Introduction to Materials
Management
SIXTH EDITION
J. R. Tony Arnold, P.E., CFPIM, CIRM
Fleming College, Emeritus
Stephen N. Chapman, Ph.D., CFPIM
North Carolina State University
Lloyd M. Clive, P.E., CFPIM
Fleming College
Upper Saddle River, New Jersey
Columbus, Ohio
Editor in Chief: Vernon R. Anthony
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ISBN-13: 978-0-13-233761-8
ISBN-10:
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PREFACE
Introduction to Materials Management is an introductory text written for students in
community colleges and universities. It is used in technical programs, such as industrial engineering and manufacturing engineering; in business programs; and by those
already in industry, whether or not they are working in materials management.
This text has been widely adopted by colleges and universities not only in
North America but also in other parts of the world. APICS—The Association for
Operations Management recommends this text as the reference for certification
preparation for various CPIM examinations. In addition, the text is used by production and inventory control societies around the world, including South Africa,
Australia, New Zealand, Germany, France, and Brazil, and by consultants who present in-house courses to their customers.
Introduction to Materials Management covers all the basics of supply chain management, manufacturing planning and control systems, purchasing, and physical distribution. The material, examples, questions, and problems lead the student logically
through the text. The writing style is simple and user-friendly—both instructors and
students who have used the book attest to this.
In the sixth edition, we have added the following:
•
•
•
•
•
•
•
•
More content on Theory of Constraints (Chapter 6)
More content on supply chains (Chapter 7)
More content on lean production (Chapter 15)
Content on the use of technology in purchasing and warehousing
(Chapters 7, 12)
The effect of global logistics and reverse logistics (Chapter 13)
Six Sigma and QFD (Chapter 16)
Small case studies at the end of several chapters
PowerPoint slides to accompany all the chapters (an online resource for
instructors)
iii
iv
Preface
In addition, we have retained several features from previous editions:
•
•
•
•
•
Margin icons to note key concepts
Key terms listed at the end of each chapter
Example problems within the chapters
Chapter summaries
Questions and problems at the end of each chapter
APPROACH AND ORGANIZATION
Materials management means different things to different people. In this textbook,
materials management includes all activities in the flow of materials from the supplier
to the consumer. Such activities include physical supply, operations planning and control, and physical distribution. Other terms sometimes used in this area are business
logistics and supply chain management. Often, the emphasis in business logistics is on
transportation and distribution systems with little concern for what occurs in the factory. Whereas some chapters in this text are devoted to transportation and distribution, emphasis is placed on operations planning and control.
Distribution and operations are managed by planning and controlling the flow
of materials through them and by using the system’s resources to achieve a desired
customer service level. These activities are the responsibility of materials management and affect every department in a manufacturing business. If the materials
management system is not well designed and managed, the distribution and manufacturing system will be less effective and more costly. Anyone working in manufacturing
or distribution should have a good basic understanding of the factors influencing
materials flow. This text aims to provide that understanding.
APICS defines the body of knowledge, concepts, and vocabulary used in production and inventory control. Establishing standard knowledge, concepts, and
vocabulary is essential both for developing an understanding of production and
inventory control and for making clear communication possible. Where applicable,
the definitions and concepts in this text subscribe to APICS vocabulary and concepts.
The first six chapters of Introduction to Materials Management cover the basics of
production planning and control. Chapter 7 discusses important factors in
purchasing and supply chain; Chapter 8 discusses forecasting. Chapters 9, 10, and 11
look at the fundamentals of inventory management. Chapter 12 discusses physical
inventory and warehouse management, and Chapter 13 examines the elements of distribution systems, including transportation, packaging, and material handling. Chapter
14 covers factors influencing product and process design. Chapter 15 looks at the
philosophy and environment of just-in-time and lean production and explains how
operations planning and control systems relate to just-in-time and lean production.
Chapter 16 examines the elements of total quality management and Six Sigma quality
approaches.
v
Preface
ONLINE INSTRUCTOR RESOURCES
To access supplementary materials online, instructors need to request an instructor
access code. Go to www.prenhall.com, click the Instructor Resource Center link, and
then click Register Today for an instructor access code. Within 48 hours after registering you will receive a confirming e-mail including an instructor access code. Once
you have received your code, go to the site and log on for full instructions on downloading the materials you wish to use.
ACKNOWLEDGMENTS
Help and encouragement have come from a number of valued sources, among them
friends, colleagues, and students. We thank the faculty of other colleges and the many
members of APICS chapters who continue to offer their support and helpful advice.
Many thanks to those who reviewed the fifth edition and provided suggestions for the
sixth edition, including members of the APICS Basics of Supply Chain Management
Certification Committee: Jim Caruso (Chair) of Tyco Healthcare; Carol Bulfer,
Parker Hanninfin Corp.; William Leedale, IFS; and Angel Sosa, University of Puerto
Rico at Bayamon. Academic reviewers included Sheila E. Rowe, North Carolina A&T
State University; David Lucero, Greenville Technical College; Floyd Olson, Utah
Valley State College; Ralph G. Kauffman, University of Houston—Downtown;
Ronald J. Baker, Shoreline Community College; and Richard E. Crandall, Appalachian
State University.
Tony Arnold thanks his wife, Vicky Arnold, for her assistance throughout the
years of writing and revising this text, and Steve Chapman thanks his wife, Jeannine, for
her support as well. Lloyd Clive thanks his wife, Kathleen, for her continued support.
Overall, this book is dedicated to those who have taught us the most—our students.
J. R. Tony Arnold, Professor Emeritus, CFPIM, CIRM
Fleming College
Peterborough, Ontario
Stephen N. Chapman, Ph.D., CFPIM, Associate Professor
Department of Business Management, College of Management
North Carolina State University
Raleigh, North Carolina
Lloyd M. Clive, CFPIM
Coordinator Materials Management and Distribution
School of Business
Fleming College
Petersborough, Ontario
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CONTENTS
CHAPTER 1
Introduction to Materials Management
Introduction 1
Operating Environment 2
The Supply Chain Concept 5
What Is Materials Management?
Supply Chain Metrics 15
Summary 17
Key Terms 17
Questions 17
Problems 18
CHAPTER 2
Production Planning System
10
20
Introduction 20
Manufacturing Planning and Control System
Sales and Operations Planning 26
Manufacturing Resource Planning 28
Enterprise Resource Planning 29
Making the Production Plan 30
Summary 42
Key Terms 42
Questions 43
Problems 44
CHAPTER 3
Master Scheduling
1
21
49
Introduction 49
Relationship to Production Plan
50
vii
viii
Contents
Developing a Master Production Schedule 53
Production Planning, Master Scheduling, and Sales
Summary 67
Key Terms 67
Questions 68
Problems 68
Case Study: Acme Water Pumps 76
CHAPTER 4
Material Requirements Planning
77
Introduction 77
Bills of Material 81
Material Requirements Planning Process 89
Using the Material Requirements Plan 102
Summary 107
Key Terms 108
Questions 108
Problems 109
Case Study: Apix Polybob Company 123
CHAPTER 5
Capacity Management
125
Introduction 125
Definition of Capacity 125
Capacity Planning 127
Capacity Requirements Planning (CRP)
Capacity Available 130
Capacity Required (Load) 135
Scheduling Orders 138
Making the Plan 141
Summary 142
Key Terms 143
Questions 144
Problems 144
Case Study: Wescott Products 149
CHAPTER 6
Production Activity Control
Introduction 153
Data Requirements 157
Order Preparation 159
Scheduling 159
Load Leveling 166
Scheduling Bottlenecks 167
153
128
60
ix
Contents
Theory of Constraints and Drum-Buffer-Rope
Implementation 172
Control 174
Production Reporting 180
Summary 181
Key Terms 181
Questions 181
Problems 183
Case Study: Johnston Products 189
CHAPTER 7
Purchasing
170
191
Introduction 191
Establishing Specifications 195
Functional Specification Description 198
Selecting Suppliers 200
Price Determination 204
Impact of Material Requirements Planning on Purchasing
Expansion of Purchasing Into Supply Chain
Management 209
Some Organizational Implications of Supply Chain
Management 211
Key Terms 212
Questions 212
Problems 213
Case Study: Let’s Party! 214
CHAPTER 8
Forecasting
216
Introduction 216
Demand Management 217
Demand Forecasting 218
Characteristics of Demand 218
Principles of Forecasting 221
Collection and Preparation of Data 222
Forecasting Techniques 223
Some Important Intrinsic Techniques 224
Seasonality 229
Tracking the Forecast 233
Summary 241
Key Terms 241
Questions 242
Problems 242
Case Study: Northcutt Bikes: The Forecasting
Problem 251
207
x
Contents
CHAPTER 9
Inventory Fundamentals
254
Introduction 254
Aggregate Inventory Management 255
Item Inventory Management 255
Inventory and the Flow of Material 256
Supply and Demand Patterns 257
Functions of Inventories 257
Objectives of Inventory Management 259
Inventory Costs 261
Financial Statements and Inventory 265
ABC Inventory Control 270
Summary 274
Key Terms 275
Questions 275
Problems 276
CHAPTER 10
Order Quantities
281
Introduction 281
Economic-Order Quantity (EOQ) 282
Variations of the EOQ Model 288
Quantity Discounts 290
Order Quantities for Families of Product When Costs
Are Not Known 291
Period-Order Quantity (POQ) 293
Summary 295
Key Terms 296
Questions 296
Problems 297
Case Study: Carl’s Computers 301
CHAPTER 11
Independent Demand Ordering Systems
304
Introduction 304
Order Point System 305
Determining Safety Stock 307
Determining Service Levels 315
Different Forecast and Lead-Time Intervals 316
Determining When the Order Point Is Reached 318
Periodic Review System 320
Distribution Inventory 322
Key Terms 326
Questions 326
Problems 327
xi
Contents
CHAPTER 12
Physical Inventory and Warehouse Management
Introduction 335
Warehousing Management 336
Physical Control and Security 342
Inventory Record Accuracy 343
Technology Applications 350
Key Terms 351
Questions 351
Problems 352
Case Study: CostMart Warehouse 356
CHAPTER 13
Physical Distribution
360
Introduction 360
Physical Distribution System 364
Interfaces 367
Transportation 368
Legal Types of Carriage 371
Transportation Cost Elements 372
Warehousing 376
Packaging 383
Materials Handling 384
Multi-Warehouse Systems 386
Key Terms 389
Questions 389
Problems 391
Case Study: Metal Specialists, Inc. 393
CHAPTER 14
Products and Processes
394
Introduction 394
Need for New Products 394
Product Development Principles 396
Product Specification and Design 398
Process Design 401
Factors Influencing Process Design 402
Processing Equipment 403
Process Systems 404
Selecting the Process 407
Continuous Process Improvement (CPI) 410
Key Terms 423
Questions 423
Problems 424
335
xii
Contents
CHAPTER 15
Just-in-Time Manufacturing and Lean Production
429
Introduction 429
Just-in-Time Philosophy 430
Waste 431
Just-in-Time Environment 434
Manufacturing Planning and Control in a JIT Environment 443
Lean Production 454
Which to Choose—MRP (ERP), Kanban, or Theory of Constraints?
Summary 458
Key Terms 459
Questions 459
Problems 460
Case Study: Murphy Manufacturing 462
Total Quality Management
CHAPTER 16
465
What Is Quality? 465
Total Quality Management (TQM) 468
Quality Cost Concepts 472
Variation as a Way of Life 473
Process Capability 476
Process Control 480
Sample Inspection 484
ISO 9000:2000 486
Benchmarking 489
Quality Function Deployment 491
JIT, TQM, and MRP II 493
Key Terms 494
Questions 495
Problems 495
Case Study: Accent Oak Furniture Company
Readings
Index
503
509
498
456
1
Introduction to Materials
Management
INTRODUCTION
The wealth of a country is measured by its gross national product—the output of
goods and services produced by the nation in a given time. Goods are physical
objects, something we can touch, feel, or see. Services are the performance of some
useful function such as banking, medical care, restaurants, clothing stores, or social
services.
But what is the source of wealth? It is measured by the amount of goods and
services produced, but where does it come from? Although we may have rich natural
resources in our economy such as mineral deposits, farmland, and forests, these are
only potential sources of wealth. A production function is needed to transform our
resources into useful goods. Production takes place in all forms of transformation—
extracting minerals from the earth, farming, lumbering, fishing, and using these
resources to manufacture useful products.
There are many stages between the extraction of resource material and the final
consumer product. At each stage in the development of the final product, value is
added, thus creating more wealth. If ore is extracted from the earth and sold, wealth is
gained from our efforts, but those who continue to transform the raw material will
gain more and usually far greater wealth. Japan is a prime example of this. It has very
few natural resources and buys most of the raw materials it needs. However, the
Japanese have developed one of the wealthiest economies in the world by transforming the raw materials they purchase and adding value to them through manufacturing.
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Chapter 1
Manufacturing companies are in the business of converting raw materials to a
form that is of far more value and use to the consumer than the original raw materials. Logs are converted into tables and chairs, iron ore into steel, and steel into cars
and refrigerators. This conversion process, called manufacturing or production, makes
a society wealthier and creates a better standard of living.
To get the most value out of our resources, we must design production
processes that make products most efficiently. Once the processes exist, we need to
manage their operation so they produce goods most economically. Managing the
operation means planning for and controlling the resources used in the process:
labor, capital, and material. All are important, but the major way in which management plans and controls is through the flow of materials. The flow of materials controls the performance of the process. If the right materials in the right quantities are
not available at the right time, the process cannot produce what it should. Labor and
machinery will be poorly utilized. The profitability, and even the existence, of the
company will be threatened.
OPERATING ENVIRONMENT
Operations management works in a complex environment affected by many factors.
Among the most important are government regulation, the economy, competition,
customer expectations, and quality.
Government. Regulation of business by the various levels of government is extensive. Regulation applies to such areas as the environment, safety, product liability,
and taxation. Government, or the lack of it, affects the way business is conducted.
Economy. General economic conditions influence the demand for a company’s
products or services and the availability of inputs. During economic recession the
demand for many products decreases while others may increase. Materials and labor
shortages or surpluses influence the decisions management makes. Shifts in the
age of the population, needs of ethnic groups, low population growth, freer trade
between countries, and increased global competition all contribute to changes in
the marketplace.
Competition. Competition is severe today.
• Manufacturing companies face competition from throughout the world. They
find foreign competitors selling in their markets even though they themselves
may not be selling in foreign markets. Companies also are resorting more to
worldwide sourcing.
• Transportation and the movement of materials are relatively less costly than
they used to be.
Introduction to Materials Management
3
• Worldwide communications are fast, effective, and cheap. Information and data
can be moved almost instantly halfway around the globe. The Internet allows
buyers to search out new sources of supply from anywhere in the world as easily
as they can from local sources.
Customers. Both consumers and industrial customers have become much more
demanding, and suppliers have responded by improving the range of characteristics
they offer. Some of the characteristics and selection customers expect in the products
and services they buy are:
•
•
•
•
•
A fair price.
Higher-(right) quality products and services.
Delivery lead time.
Better presale and after-sale service.
Product and volume flexibility.
Quality. Since competition is international and aggressive, successful companies
provide quality that not only meets customers’ high expectations but exceeds them.
Chapter 16 discusses quality in detail.
Order qualifiers and order winners. Generally a supplier must meet set minimum requirements to be considered a viable competitor in the marketplace.
Customer requirements may be based on price, quality, delivery, and so forth and are
called order qualifiers. For example, the price for a certain type of product must fall
within a range for the supplier to be considered. But being considered does not mean
winning the order. To win orders a supplier must have characteristics that encourage
customers to choose its products and services over competitors’. Those competitive
characteristics, or combination of characteristics, that persuade a company’s customers to choose its products or services are called order winners. They provide a
competitive advantage for the firm. Order winners change over time and may well be
different for different markets. For example, fast delivery may be vital in one market
but not in another. Characteristics that are order winners today probably will not
remain so, because competition will try to copy winning characteristics, and the needs
of customers will change.
It is very important that a firm understands the order winners and order qualifiers for each of their products and in each of their markets because they should drive
the manufacturing strategy. Since it is virtually impossible to be the best in every
dimension of competition, firms should in general strive to provide at least a minimal
level of acceptance for each of the order qualifiers but should try to be the best in the
market for the order winner(s).
One also should recognize that the order winners and qualifiers for any
product/market combination are not static. Not only will customers change perspectives as competitors jockey for position, but the order winners and qualifiers will
often change based on the concepts of the product life cycle. The product life cycle
4
Chapter 1
implies that most products go through a life cycle, including introduction, growth,
maturity, and decline. For example, in the introduction phase, design and availability
are often much more important than price. Quality and delivery tend to have
increased importance during growth, while price and delivery are often the order
winners for mature products. This life cycle approach is complicated in that the duration of the life cycle will be very different for different products. Although some products have life cycles many years long, other products (certain toys or electronics, for
example) can be measured in months or even weeks.
Manufacturing Strategy
A highly market-oriented company will focus on meeting or exceeding customer
expectations and on order winners. In such a company all functions must contribute
toward a winning strategy. Thus, operations must have a strategy that allows it to
supply the needs of the marketplace and provide fast on-time delivery.
Delivery lead time. From the supplier’s perspective, this is the time from receipt
of an order to the delivery of the product. From the customer’s perspective it may
also include time for order preparation and transmittal. Customers want delivery lead
time to be as short as possible, and manufacturing must design a strategy to achieve
this. There are four basic strategies: engineer-to-order, make-to-order, assemble-toorder, and make-to-stock. Customer involvement in the product design, delivery lead
time, and inventory state are influenced by each strategy. Figure 1.1 shows the effect
of each strategy.
Engineer-to-order means that the customer’s specifications require unique
engineering design or significant customization. Usually the customer is highly
Delivery Lead Time
DESIGN
PURCHASE
MANUFACTURE
ASSEMBLE
SHIP
ENGINEER-TOORDER
SHIP
MAKE-TOORDER
Delivery Lead Time
INVENTORY
MANUFACTURE
ASSEMBLE
Delivery Lead Time
MANUFACTURE
ASSEMBLE
SHIP
ASSEMBLETO-ORDER
INVENTORY
SHIP
MAKE-TOSTOCK
INVENTORY
Delivery Lead Time
MANUFACTURE
ASSEMBLE
Figure 1.1 Manufacturing strategy and lead time.
5
Introduction to Materials Management
involved in the product design. Inventory will not normally be purchased until needed
by manufacturing. Delivery lead time is long because it includes not only purchase
lead time but design lead time as well.
Make-to-order means that the manufacturer does not start to make the product
until a customer’s order is received. The final product is usually made from standard
items but may include custom-designed components as well. Delivery lead time
is reduced because there is little design time required and inventory is held as raw
material.
Assemble-to-order means that the product is made from standard components
that the manufacturer can inventory and assemble according to a customer order.
Delivery lead time is reduced further because there is no design time needed and
inventory is held ready for assembly. Customer involvement in the design of the product is limited to selecting the component part options needed.
Make-to-stock means that the supplier manufactures the goods and sells from
finished goods inventory. Delivery lead time is shortest. The customer has little direct
involvement in the product design.
THE SUPPLY CHAIN CONCEPT
There are three phases to the flow of materials. Raw materials flow into a manufacturing company from a physical supply system, they are processed by manufacturing,
and finally finished goods are distributed to end consumers through a physical distribution system. Figure 1.2 shows this system graphically. Although this figure shows
only one supplier and one customer, usually the supply chain consists of several companies linked in a supply/demand relationship. For example, the customer of one supplier buys a product, adds value to it, and supplies yet another customer. Similarly, one
S
U
P
P
L
I
E
R
Physical
Supply
MANUFACTURER
DISTRIBUTION
SYSTEM
Manufacturing,
Planning, and
Control
Physical Distribution
C
U
S
T
O
M
E
R
DOMINANT FLOW OF PRODUCTS AND SERVICES
DOMINANT FLOW OF DEMAND AND DESIGN INFORMATION
Figure 1.2 Supply-production-distribution system.
6
Chapter 1
customer may have several suppliers and may in turn supply several customers.
As long as there is a chain of supplier/customer relationships, they are all members of
the same supply chain.
There are a number of important factors in supply chains:
• The supply chain includes all activities and processes to supply a product or
service to a final customer.
• Any number of companies can be linked in the supply chain.
• A customer can be a supplier to another customer so the total chain can have a
number of supplier/customer relationships.
• Although the distribution system can be direct from supplier to customer,
depending on the products and markets, it can contain a number of intermediaries (distributors) such as wholesalers, warehouses, and retailers.
• Product or services usually flow from supplier to customer and design, and
demand information usually flows from customer to supplier. Rarely is this
not so.
Although these systems vary from industry to industry and company to company,
the basic elements are the same: supply, production, and distribution. The relative
importance of each depends on the costs of the three elements.
Supply Chain Concepts
In recent years there has been a great deal of attention to the concept of supply chain
management (SCM). It is important to understand the fundamental issues behind
this movement, as well as the impact on materials management.
Historical perspective. In the past, many company managers placed most of their
attention on the issues that were internal to their companies. Of course they were
aware of the impact of suppliers, customers, and distributors, but those entities were
often viewed as business entities only. Specialists in purchasing, sales, and logistics
were assigned to “deal” with those outside entities, often through formal legal contracts that were negotiated regularly and represented short-term agreements. For
example, suppliers were often viewed as business adversaries. A key responsibility of
a purchasing agent was to negotiate the best financial and delivery conditions from a
supplier, whose job was to maximize his company’s profit. Organization theorists
often called the functions that dealt with outside entities boundary spanners, indicating that for most people in the organization there were well-defined and rigid boundaries between their organization and the rest of the world.
The first major change in that perspective for most companies can be traced to
the explosive growth in just-in-time (JIT) concepts originally developed by Toyota
and other Japanese companies in the 1970s. Supplier partnerships were felt to be a
major aspect of successful JIT. With that concept, suppliers were viewed as partners
as opposed to adversaries. In that sense the supplier and the customer had mutually
Introduction to Materials Management
7
linked destinies, in that the success of each was linked to the success of the other.
Great emphasis was put on trust between the partners, and many of the formal
boundary mechanisms, such as the receiving/inspection activity of incoming parts,
were changed or eliminated altogether. As the partnership concept grew, there were
many other changes in the relationship including:
• Mutual analysis for cost reduction. Both parties examined the process used to
transmit information and deliver parts, with the idea that cost reductions would
be shared between the two parties.
• Mutual product design. In the past the customer often submitted complete
designs to the supplier who was obligated to produce according to design.
With partnering, both companies worked together. Often the supplier would
know more about how to make a specific product, whereas the customer
would know more about the application for which the design was intended.
Together, they could probably produce a superior design compared to what
either could do alone.
• With JIT, the concept of greatly reduced inventory in the process and the need
for rapid delivery according to need, the speed of accurate information flow
became critical. Formal paper-based systems gave way to electronic data interchange and informal communication methods.
The growth of the supply chain concept. As the 1980s gave way to the 1990s,
the world continued to change, forcing additional modifications to the trend:
• There has been explosive growth in computer capability and associated software applications. Highly effective and integrated systems such as enterprise
resource planning (ERP) and the ability to link companies electronically
(through the Internet, for example) have allowed companies to share large
amounts of information quickly and easily. The ability to have the information
rapidly has become a competitive necessity for many companies.
• There has been a large growth in global competition. Very few companies
can still say they have only local competition, and many of the global competitors are forcing existing companies to find new ways to be successful in the
marketplace.
• There has been a growth in technological capabilities for products and
processes. Product life cycles for many products are shrinking rapidly, forcing
companies to not only become more flexible in design but also to communicate
changes and needs to suppliers and distributors.
• The changes prompted by JIT in the 1980s have continued to mature, so that by
now many companies have new approaches to interorganizational relationships
as a normal form of business.
• Partially in response to the preceding conditions, more and more companies are
subcontracting more of their work to suppliers, keeping only their most important core competencies as internal activities.
8
Chapter 1
What is the current supply chain concept? Companies currently adopting the
supply chain concept view the entire set of activities from raw material production to
final customer purchase to final disposal as a linked chain of activities. To result in
optimal performance for customer service and cost, it is felt that the supply chain of
activities should be managed as an extension of the partnership. This implies many
issues, but three critical ones include:
1. Flow of materials.
2. Flow of information and sharing of information, mostly through the Internet.
3. Fund transfers.
In addition, a new trend is to manage the recovery, recycling, and reuse of material.
The primary supply chain management approach is a conceptual one. All portions of the material production, from raw materials to final customer, are considered
to be a linked chain. The most efficient and effective way to manage the activities
along the chain is to view each separate organization in the chain as an extension of
one’s own organization. There can be many organizations in a supply chain. Take as
an example the chain of organizations that represent the flow from raw silicon used to
make computer chips to the delivery and disposal of the computer itself:
SILICON
PRODUCTION
INTEGRATED
CIRCUIT (CHIP)
PRODUCTION
DISTRIBUTOR
RETAILER
PRINTED CIRCUIT
BOARD PRODUCTION
CUSTOMER
COMPUTER
PRODUCTION
DISPOSAL
What is illustrated here is but one chain of a set of different component chains
that represent a network of suppliers and distributors for a product.
To manage a supply chain, one must not only understand the network of suppliers and customers along the chain but must also try to efficiently plan material and
information flows along each chain to maximize cost efficiency, effectiveness, delivery,
and flexibility. This clearly not only implies taking a different conceptual approach to
suppliers and customers but also implies a highly integrated information system and a
different set of performance measures. Overall, the key to managing such a concept is
with rapid flows of accurate information and increased organizational flexibility.
Conflicts in Traditional Systems
In the past, supply, production, and distribution systems were organized into separate
functions that reported to different departments of a company. Often policies and
practices of the different departments maximized departmental objectives without
Introduction to Materials Management
9
considering the effect they would have on other parts of the system. Because the
three systems are interrelated, conflicts often occurred. Although each system made
decisions that were best for itself, overall company objectives suffered. For example,
the transportation department would ship in the largest quantities possible so it could
minimize per-unit shipping costs. However, this increased inventory and resulted in
higher inventory-carrying costs.
To get the most profit, a company must have at least four main objectives:
1.
2.
3.
4.
Provide best customer service.
Provide lowest production costs.
Provide lowest inventory investment.
Provide lowest distribution costs.
These objectives create conflict among the marketing, production, and finance
departments because each has different responsibilities in these areas.
Marketing’s objective is to maintain and increase revenue; therefore, it must
provide the best customer service possible. There are several ways of doing this:
• Maintain high inventories so goods are always available for the customer.
• Interrupt production runs so that a noninventoried item can be manufactured
quickly.
• Create an extensive and costly distribution system so goods can be shipped to
the customer rapidly.
Finance must keep investment and costs low. This can be done in the following
ways:
•
•
•
•
Reduce inventory so inventory investment is at a minimum.
Decrease the number of plants and warehouses.
Produce large quantities using long production runs.
Manufacture only to customer order.
Production must keep its operating costs as low as possible. This can be done in
the following ways:
• Make long production runs of relatively few products. Fewer changeovers will
be needed and specialized equipment can be used, thus reducing the cost of
making the product.
• Maintain high inventories of raw materials and work-in-process so production
is not disrupted by shortages.
These conflicts among marketing, finance, and production center on customer
service, disruption of production flow, and inventory levels. Figure 1.3 shows this
relationship.
10
Chapter 1
FUNCTION
OBJECTIVE
IMPLICATION
• High Revenues
• High Product
Availability
High
Production
• Low Production
Cost
• High-Level
Production
• Long Production
Runs
Many Disruptions
to
Few
Production
Finance
• Low Investment
and Cost
• Fewer Fixed
Costs
• Low Inventories
Marketing
Customer Service
Low
High
Inventories
Low
Figure 1.3 Conflicting objectives.
Today the concepts of JIT manufacturing stress the need to supply customers
with what they want when they want it and to keep inventories at a minimum. These
objectives put further stress on the relationship among production, marketing, and
finance. Chapter 15 will discuss the concepts of JIT manufacturing and how it influences materials management.
One important way to resolve these conflicting objectives is to provide close
coordination of the supply, production, and distribution functions. The problem is to
balance conflicting objectives to minimize the total of all the costs involved and maximize customer service consistent with the goals of the organization. This requires
some type of integrated materials management or logistics organization that is
responsible for supply, production, and distribution. Rather than having the planning
and control of these functions spread among marketing, production, and distribution,
they should occur in a single area of responsibility.
WHAT IS MATERIALS MANAGEMENT?
The concept of having one department responsible for the flow of materials, from
supplier through production to consumer, is relatively new. Although many companies have adopted this type of organization, there are still a number that have not.
If companies wish to minimize total costs in this area and provide a better level of
customer service, they will move in this direction.
The name usually given to this function is materials management. Other names
include distribution planning and control and logistics management, but the one used
in this text is materials management.
11
Introduction to Materials Management
Materials management is a coordinating function responsible for planning and
controlling materials flow. Its objectives are as follows:
• Maximize the use of the firm’s resources.
• Provide the required level of customer service.
Materials management can do much to improve a company’s profit. An income
(profit and loss) statement for a manufacturing company might look something like
the following:
Revenue (sales)
Cost of Goods Sold
Direct Material
Direct Labor
Factory Overhead
Total Cost of Goods Sold
Gross Profit
Dollars
$1,000,000
$500,000
$200,000
$200,000
Percent of Sales
100
50
20
20
$900,000
$100,000
90
10
Direct labor and direct material are costs that increase or decrease with the
quantity sold. Overhead (all other costs) does not vary directly with sales. For simplicity this section assumes overhead is constant, even though it is initially expressed
as a percentage of sales.
If, through a well-organized materials management department, direct materials can be reduced by 10% and direct labor by 5%, the improvement in profit
would be:
Revenue (sales)
Cost of Goods Sold
Direct Material
Direct Labor
Overhead
Total Cost of Goods Sold
Gross Profit
Dollars
$1,000,000
$450,000
$190,000
$200,000
Percent of Sales
100
45
19
20
$840,000
$160,000
84
16
Profit has been increased by 60%. To get the same increase in profit ($60,000)
by increasing revenue, sales would have to increase to $1.2 million.
Revenue (sales)
Cost of Goods Sold
Direct Material
Direct Labor
Overhead
Total Cost of Goods Sold
Gross Profit
Dollars
$1,200,000
$600,000
$240,000
$200,000
Percent of Sales
100
50
20
17
$1,040,000
$160,000
87
13
12
Chapter 1
EXAMPLE PROBLEM
a. If the cost of direct material is 60%, direct labor is 10%, and overhead is 25% of
sales, what will be the improvement in profit if direct material is reduced to 55%?
b. How much will sales have to increase to give the same increase in profit?
(Remember, overhead cost is constant.)
Answer
a.
Revenue (sales)
Cost of Goods Sold
Direct Material
Direct Labor
Overhead
Total Cost of Goods Sold
Gross Profit
b.
Before Improvement
100%
60%
10%
25%
After improvement
100%
55%
10%
25%
95%
5%
90%
10%
Profit =
=
=
.1 =
0.3 Sales =
sales - 1direct material + direct labor + 0.252
sales - 10.6 sales + 0.1 sales + 0.252
sales - 0.7 sales - 0.25
0.3 sales - 0.25
0.35
0.35
Sales =
= 1.17
0.3
Sales must increase 17% to give the same increase in profit.
Work-in-Process
Inventory not only makes up a portion of the cost of goods sold but has to be
purchased at the beginning of production to be processed into finished goods. This
type of inventory is called work-in-process (WIP). WIP is a major investment
for many companies, and reducing the amount of time that inventory spends in
production is a good way to reduce the costs associated with this investment. Labor,
materials and overhead are applied to goods continuously throughout production
and the value of the WIP is estimated to be one half the final value. Further discussion on WIP and reducing it is covered in Chapters 9 and 15.
EXAMPLE PROBLEM
On the average, a company has 12 weeks of WIP inventory and annual cost of goods
sold of $36 million. Assuming the company works 50 weeks per year:
a. What is the dollar value of the WIP?
b. If the WIP could be reduced to 5 weeks, and the annual cost of carrying inven-
tory was 20% of the inventory value, what would be the annual savings?
Introduction to Materials Management
13
Answer
Weekly Cost of Goods Sold = $36,000,000 per year>50 weeks per year
= $720,000/week
Value of 12 Weeks WIP = 12 weeks * $720,000>week * 1>2 = $4,320,000
Value of 5 Weeks WIP = 5 weeks * $720,000>week * 1>2 = $1,800,000
Reduction in WIP = $4,320,000 - $1,800,000 = $2,520,000
Annual Savings = $2,520,000 * 20% = $504,000
Reducing cost contributes directly to profit. Increasing sales increases direct
costs of labor and materials so profit does not increase directly. Materials management can reduce costs by being sure that the right materials are in the right place at
the right time and the resources of the company are properly used.
There are several ways of classifying this flow of material. A very useful classification, and the one used in this text, is manufacturing planning and control and physical supply/distribution.
Manufacturing Planning and Control
Manufacturing planning and control are responsible for the planning and control of
the flow of materials through the manufacturing process. The primary activities carried out are as follows:
1. Production planning. Production must be able to meet the demand of the marketplace. Finding the most productive way of doing so is the responsibility of production planning. It must establish correct priorities (what is needed and when)
and make certain that capacity is available to meet those priorities. It will involve:
a. Forecasting.
b. Master planning.
c. Material requirements planning.
d. Capacity planning.
2. Implementation and control. These are responsible for putting into action and
achieving the plans made by production planning. These responsibilities are
accomplished through production activity control (often called shop floor control) and purchasing.
3. Inventory management. Inventories are materials and supplies carried on hand
either for sale or to provide material or supplies to the production process.
They are part of the planning process and provide a buffer against the differences in demand rates and production rates.
Production planning, implementation, control, and inventory management
work together. Inventories in manufacturing are used to support production or are
the result of production. Only if items are purchased and resold without further
14
Chapter 1
processing can inventory management operate separately from production planning
and control. Even then, it cannot operate apart from purchasing.
Inputs to the manufacturing planning and control system.
basic inputs to the manufacturing planning and control system:
There are five
1. The product description shows how the product will appear at some stage of
production. Engineering drawings and specifications are methods of describing
the product. Another method, and the most important for manufacturing planning and control, is the bill of material. As used in materials management, this
document does two things:
• Describes the components used to make the product.
• Describes the subassemblies at various stages of manufacture.
2. Process specifications describe the steps necessary to make the end product.
They are a step-by-step set of instructions describing how the product is made.
This information is usually recorded on a route sheet or in a routing file. These
are documents or computer files that give information such as the following on
the manufacture of a product:
• Operations required to make the product.
• Sequence of operations.
• Equipment and accessories required.
• Standard time required to perform each operation.
3. The time needed to perform operations is usually expressed in standard time
which is the time taken by an average operator, working at a normal pace, to
perform a task. It is needed to schedule work through the plant, load the plant,
make delivery promises, and cost the product. Usually, standard times for operations are obtained from the routing file.
4. Available facilities. Manufacturing planning and control must know what plant,
equipment, and labor will be available to process work. This information is usually found in the work center file.
5. Quantities required. This information will come from forecasts, customer orders,
orders to replace finished-goods inventory, and the material requirements plan.
Physical Supply/Distribution
Physical supply/distribution includes all the activities involved in moving goods, from
the supplier to the beginning of the production process, and from the end of the production process to the consumer.
The activities involved are as follows:
• Transportation.
• Distribution inventory.
• Warehousing.
Introduction to Materials Management
15
• Packaging.
• Materials handling.
• Order entry.
Materials management is a balancing act. The objective is to be able to deliver
what customers want, when and where they want it, and do so at minimum cost. To
achieve this objective, materials management must make trade-offs between the level
of customer service and the cost of providing that service. As a rule, costs rise as the service level increases, and materials management must find that combination of inputs to
maximize service and minimize cost. For example, customer service can be improved by
establishing warehouses in major markets. However, that causes extra cost in operating
the warehouse and in the extra inventory carried. To some extent, these costs will be offset by potential savings in transportation costs if lower cost transportation can be used.
By grouping all those activities involved in the movement and storage of goods
into one department, the firm has a better opportunity to provide maximum service
at minimum cost and to increase profit. The overall concern of materials management is the balance between priority and capacity. The marketplace sets demand.
Materials management must plan the firm’s priorities (what goods to make and
when) to meet that demand. Capacity is the ability of the system to produce or deliver
goods. Priority and capacity must be planned and controlled to meet customer
demand at minimum cost. Materials management is responsible for doing this.
SUPPLY CHAIN METRICS
A metric is a verifiable measure stated in either quantitative or qualitative terms
defined with respect to a reference point. Without metrics, no firm could expect to
function effectively or efficiently on a daily basis. Metrics give us:
1.
2.
3.
4.
5.
Control by superiors.
Reporting of data to superiors and external groups.
Communication.
Learning.
Improvement.
Metrics communicate expectations, identify problems, direct a course of action,
and motivate people. Building the right metrics is vital to a company. Problems must
be anticipated and corrective action taken before they become severe. Thus, companies cannot risk waiting to react until the order cycle is completed and feedback from
customers is received.
Today production control works in a demanding environment shaped by six
major challenges:
1. Customers that are never satisfied.
2. A supply chain that is large and must be managed.
16
Chapter 1
Focus
Strategy
Strategic
Metrics
Operational
Customer
Standard
Figure 1.4 Metrics context.
3.
4.
5.
6.
A product life cycle that is getting shorter and shorter.
A vast amount of data.
An emphasis on profit margins that are more squeezed.
An increasing number of alternatives.
A firm has a corporate strategy that states how it will treat its customers and
what services it will supply. This identifies how a firm will compete in the marketplace. It is the customer who assesses the firm’s offering by its decision to buy or not
to buy. Metrics link strategy to operations. Finally, the two are brought together by
metrics. Figure 1.4 shows this graphically.
The right-hand side of the figure deals with operations and with the implementation and use of metrics. Focus describes the particular activity that is to be measured.
Standards are the yardstick that is the basis of comparison on which performance is
judged.
There is a difference between measurement and standards. A performance
measure must be both quantified and objective and contain at least two parameters.
For example, the number of orders per day consists of both a quantity and a time
measurement.
Transforming company policies into objectives and specific goals creates
performance standards. Each goal should have target values. An example of this
would be to improve order fill rate to 98% measured by number of lines. Performance
standards set the goal, while performance measures say how close you came.
Many companies do not realize the potential benefits of performance measurement, nor do they know how to measure performance. It can be used without performance standards. This might occur when the concept of performance measurement
and standards is new. When standards are put into use, management can begin
to monitor the company. The old saying, “What you do not measure, you cannot
control,” is as valid today as it was when first stated.
The necessary steps in implementing such a program are:
1.
2.
3.
4.
5.
6.
Establish company goals and objectives.
Define performance.
State the measurement to be used.
Set performance standards.
Educate the user.
Make sure the program is consistently applied.
Although financial performance has traditionally been the measure of success
in most companies, today the focus is on continuous improvement and, with this, an
17
Introduction to Materials Management
increase in standards. Emphasis should not be placed on a “one-shot” improvement
but on such things as the rate of improvement in quality, cost, reliability, innovation,
effectiveness, and productivity.
SUMMARY
Manufacturing creates wealth by adding value to goods. To improve productivity and
wealth, a company must first design efficient and effective systems for manufacturing.
It must then manage these systems to make the best use of labor, capital, and material. One of the most effective ways of doing this is through the planning and control
of the flow of materials into, through, and out of manufacturing. There are three
elements to a material flow system: supply, manufacturing planning and control, and
physical distribution. They are connected, and what happens in one system affects
the others.
Traditionally, there are conflicts in the objectives of a company and in the objectives of marketing, finance, and production. The role of materials management is to
balance these conflicting objectives by coordinating the flow of materials so customer
service is maintained and the resources of the company are properly used.
This text will examine some of the theory and practice considered to be part of
the “body of knowledge” as presented by the Association for Operations Management
(APICS). Chapter 15 will study the concepts of Just-in-Time manufacturing to see how
they affect the practice of materials management.
KEY TERMS
Order qualifiers 3
Order winners 3
Engineer-to-order 4
Make-to-order 5
Assemble-to-order 5
Make-to-stock 5
Materials management 10
Work-in-process 12
Production planning 13
Implementation and
control 13
Inventory management 13
Product description 14
Bill of material 14
Process specifications 14
Time needed to perform
operations 14
Available facilities 14
Quantities required 14
Metric 15
Performance measure 16
Performance standards 16
QUESTIONS
1. What is wealth, and how is it created?
2. What is value added, and how is it achieved?
3. Name and describe four major factors affecting operations management.
4. What are an order qualifier and an order winner?
18
Chapter 1
5. Describe the four primary manufacturing strategies. How does each affect delivery lead
time?
6. What is a supply chain? Describe five important factors in supply chains.
7. What must manufacturing management do to manage a process or operation? What is
the major way in which management plans and controls?
8. Name and describe the three main divisions of supply, production, and distribution
systems.
9. What are the four objectives of a firm wishing to maximize profit?
10. What is the objective of marketing? What three ways will help it achieve this objective?
11. What are the objectives of finance? How can these objectives be met?
12. What are the objectives of production? How can these objectives be met?
13. Describe how the objectives of marketing, production, and finance are in conflict over
customer service, disruption to production, and inventories.
14. What is the purpose of materials management?
15. Name and describe the three primary activities of manufacturing planning and control.
16. Name and describe the inputs to a manufacturing planning and control system.
17. What are the six activities involved in the physical supply/distribution system?
18. Why can materials management be considered a balancing act?
19. What are metrics? What are their uses?
20. A computer carrying case and a backpack are familiar items to a student of manufacturing planning and control. Discuss the manufacturing planning and control activities
involved in producing a variety of these products. What information from other departments is necessary for manufacturing planning and control to perform its function?
PROBLEMS
1.1
If the cost of manufacturing (direct material and direct labor) is 60% of sales and profit
is 10% of sales, what would be the improvement in profit if, through better planning and
control, the cost of manufacturing was reduced from 60% of sales to 50% of sales?
Answer.
1.2
In problem 1.1, how much would sales have to increase to provide the same increase in
profits?
Answer.
1.3
Profits would improve by 100%.
Sales would have to increase 25%.
On the average, a firm has 10 weeks of work-in-process, and annual cost of goods sold is
$15 million. Assuming that the company works 50 weeks a year:
a. What is the dollar value of the work-in-process?
b. If the work-in-process could be reduced to 7 weeks and the annual cost of carrying
inventory was 20% of the inventory value, what would be the annual saving?
Answer.
a. $1,500,000
b. $90,000
Introduction to Materials Management
1.4
19
On the average, a company has 12 weeks of work-in-process and annual cost of goods
sold of $40 million. Assuming that the company works 50 weeks a year:
a. What is the dollar value of the work-in-process?
b. If the work-in-process could be reduced to 5 weeks and the annual cost of carrying
inventory was 20% of the inventory value, what would be the annual saving?
1.5
Amalgamated Fenderdenter’s sales are $10 million. The company spends $3.5 million
for purchase of direct materials and $2.5 million for direct labor; overhead is $3.5 million
and profit is $500,000. Direct labor and direct material vary directly with the cost of
goods sold, but overhead does not. The company wants to double its profit.
a. By how much should the firm increase sales?
b. By how much should the firm decrease material costs?
c. By how much should the firm decrease labor cost?
2
Production Planning System
INTRODUCTION
This chapter introduces the manufacturing planning and control system. First, it deals
with the total system and then with some details involved in production planning.
Subsequent chapters discuss master scheduling, material requirements planning,
capacity management, production activity control, purchasing, and forecasting.
Manufacturing is complex. Some firms make a few different products, whereas
others make many products. However, each uses a variety of processes, machinery, equipment, labor skills, and material. To be profitable, a firm must organize all these factors to
make the right goods at the right time at top quality and do so as economically as possible.
It is a complex problem, and it is essential to have a good planning and control system.
A good planning system must answer four questions:
1.
2.
3.
4.
What are we going to make?
What does it take to make it?
What do we have?
What do we need?
These are questions of priority and capacity.
Priority relates to what products are needed, how many are needed, and when
they are needed. The marketplace establishes the priorities. Manufacturing is responsible for devising plans to satisfy the market demand if possible.
20
21
Production Planning System
Figure 2.1 Priority-capacity
relationship.
PRIORITY
(Demand)
CAPACITY
(Resources)
Capacity is the capability of manufacturing to produce goods and services.
Eventually it depends on the resources of the company—the machinery, labor, and
financial resources, and the availability of material from suppliers. In the short run,
capacity is the quantity of work that labor and equipment can perform in a given
period. The relationship that should exist between priority and capacity is shown
graphically in Figure 2.1.
In the long and short run, manufacturing must devise plans to balance the
demands of the marketplace with its resources and capacity. For long-range decisions, such as the building of new plants or the purchase of new equipment, the plans
must be made for several years. For planning production over the next few weeks, the
time span will be days or weeks. This hierarchy of planning, from long range to short
range, is covered in the next section.
MANUFACTURING PLANNING AND CONTROL SYSTEM
There are five major levels in the manufacturing planning and control (MPC) system:
•
•
•
•
•
Strategic business plan.
Production plan (sales and operations plan).
Master production schedule.
Material requirements plan.
Purchasing and production activity control.
Each level varies in purpose, time span, and level of detail. As we move from
strategic planning to production activity control, the purpose changes from general
direction to specific detailed planning, the time span decreases from years to days,
and the level of detail increases from general categories to individual components
and workstations.
Since each level is for a different time span and for different purposes, each differs in the following:
• Purpose of the plan.
• Planning horizon—the time span from now to some time in the future for which
the plan is created.
• Level of detail—the detail about products required for the plan.
• Planning cycle—the frequency with which the plan is reviewed.
22
Chapter 2
At each level, three questions must be answered:
1. What are the priorities—how much of what is to be produced and when?
2. What is the available capacity—what resources do we have?
3. How can differences between priorities and capacity be resolved?
Figure 2.2 shows the planning hierarchy. The first four levels are planning levels. The result of the plans is authorization to purchase or manufacture what is
required. The final level is when the plans are put into action through production
activity control and purchasing.
The following sections will examine each of the planning levels by purpose,
horizon, level of detail, and planning cycle.
The Strategic Business Plan
The strategic business plan is a statement of the major goals and objectives the company expects to achieve over the next 2 to 10 years or more. It is a statement of the
broad direction of the firm and shows the kind of business—product lines, markets,
and so on—the firm wants to do in the future. The plan gives general direction about
how the company hopes to achieve these objectives. It is based on long-range
Figure 2.2 Manufacturing
planning and control system.
STRATEGIC
BUSINESS
PLAN
PRODUCTION
PLAN
MASTER
PRODUCTION
SCHEDULE
MASTER
PLAN
PLANNING
MATERIAL
REQUIREMENTS
PLAN
PRODUCTION
ACTIVITY CONTROL
AND
PURCHASING
IMPLEMENTATION
23
Production Planning System
forecasts and includes participation from marketing, finance, production, and engineering. In turn, the plan provides direction and coordination among the marketing,
production, financial, and engineering plans.
Marketing is responsible for analyzing the marketplace and deciding the firm’s
response: the markets to be served, the products supplied, desired levels of customer
service, pricing, promotion strategies, and so on.
Finance is responsible for deciding the sources and uses of funds available to
the firm, cash flows, profits, return on investment, and budgets.
Production must satisfy the demands of the marketplace. It does so by using
plants, machinery, equipment, labor, and materials as efficiently as possible.
Engineering is responsible for research, development, and design of new products or modifications to existing ones. Engineering must work with marketing and
production to produce designs for products that will sell in the marketplace and can
be made most economically.
The development of the strategic business plan is the responsibility of senior
management. Using information from marketing, finance, and production, the strategic business plan provides a framework that sets the goals and objectives for further
planning by the marketing, finance, engineering, and production departments. Each
department produces its own plans to achieve the objectives set by the strategic business plan. These plans will be coordinated with one another and with the strategic
business plan. Figure 2.3 shows this relationship.
Production
Plan
Financial
Plan
STRATEGIC
BUSINESS
PLAN
Engineering
Plan
Figure 2.3 Business plan.
Marketing
Plan
24
Chapter 2
The level of detail in the strategic business plan is not high. It is concerned
with general market and production requirements—total market for major product
groups, perhaps—and not sales of individual items. It is often stated in dollars rather
than units.
Strategic business plans are usually reviewed every six months to a year.
The Production Plan
Given the objectives set by the strategic business plan, production management is
concerned with the following:
•
•
•
•
The quantities of each product group that must be produced in each period.
The desired inventory levels.
The resources of equipment, labor, and material needed in each period.
The availability of the resources needed.
The level of detail is not high. For example, if a company manufactures children’s bicycles, tricycles, and scooters in various models, each with many options, the
production plan will show major product groups, or families: bicycles, tricycles, and
scooters.
Production planners must devise a plan to satisfy market demand within the
resources available to the company. This will involve determining the resources
needed to meet market demand, comparing the results to the resources available,
and devising a plan to balance requirements and availability.
This process of determining the resources required and comparing them to the
available resources takes place at each of the planning levels and is the problem of
capacity management. For effective planning, there must be a balance between priority and capacity.
Along with the market and financial plans, the production plan is concerned
with implementing the strategic business plan. The planning horizon is usually 6 to 18
months and is reviewed perhaps each month or quarter.
The Master Production Schedule
The master production schedule (MPS) is a plan for the production of individual end
items. It breaks down the production plan to show, for each period, the quantity of
each end item to be made. For example, it might show that 200 Model A23 scooters
are to be built each week. Inputs to the MPS are the production plan, the forecast for
individual end items, sales orders, inventories, and existing capacity.
The level of detail for the MPS is higher than for the production plan. Whereas
the production plan was based upon families of products (tricycles), the master production schedule is developed for individual end items (each model of tricycle). The
planning horizon usually extends from 3 to 18 months but primarily depends on the
25
Production Planning System
purchasing and manufacturing lead times. This is discussed in Chapter 3 in the
section on master scheduling. The term master scheduling describes the process of
developing a master production schedule. The term master production schedule is the
end result of this process. Usually, the plans are reviewed and changed weekly or
monthly.
The Material Requirements Plan
The material requirements plan (MRP) is a plan for the production and purchase of
the components used in making the items in the master production schedule. It shows
the quantities needed and when manufacturing intends to make or use them.
Purchasing and production activity control use the MRP to decide the purchase or
manufacture of specific items.
The level of detail is high. The material requirements plan establishes when the
components and parts are needed to make each end item.
The planning horizon is at least as long as the combined purchase and manufacturing lead times. As with the master production schedule, it usually extends from
3 to 18 months.
Purchasing and Production Activity Control
Purchasing and production activity control (PAC) represent the implementation and
control phase of the production planning and control system. Purchasing is responsible for establishing and controlling the flow of raw materials into the factory. PAC is
responsible for planning and controlling the flow of work through the factory.
The planning horizon is very short, perhaps from a day to a month. The level of
detail is high since it is concerned with individual components, workstations, and
orders. Plans are reviewed and revised daily.
Figure 2.4 shows the relationship among the various planning tools, planning
horizons, and level of detail.
LEVEL OF DETAIL
PAC
MRP
MPS
Production
Plan
Strategic
Business
Plan
PLANNING HORIZON (Time)
Figure 2.4 Level of detail versus planning horizon.
26
Chapter 2
The levels discussed in the preceding sections are examined in more detail in
later chapters. This chapter discusses production planning. Later chapters deal with
master scheduling, material requirements planning, and production activity control.
Capacity Management
At each level in the manufacturing planning and control system, the priority plan
must be tested against the available resources and capacity of the manufacturing system. Chapter 5 describes some of the details of capacity management. For now, it is
sufficient to understand that the basic process is one of calculating the capacity
needed to manufacture the priority plan and of finding methods to make that capacity available. There can be no valid, workable production plan unless this is done. If
the capacity cannot be made available when needed, then the plans must be changed.
Determining the capacity required, comparing it to available capacity, and making adjustments (or changing plans) must occur at all levels of the manufacturing
planning and control system.
Over several years, machinery, equipment, and plants can be added to or taken
away from manufacturing. However, in the time spans involved from production
planning to production activity control, these kinds of changes cannot be made. Some
changes, such as changing the number of shifts, working overtime, subcontracting the
work, and so on, can be accomplished in these time spans.
SALES AND OPERATIONS PLANNING
The strategic business plan integrates the plans of all the departments in an organization and is normally updated annually. However, these plans should be updated
as time progresses so that the latest forecasts and market and economic conditions are taken into account. Sales and operations planning (SOP) is a process for
continually revising the strategic business plan and coordinating plans of the various
departments. SOP is a cross-functional business plan that involves sales and marketing, product development, operations, and senior management. Although operations
represents supply, marketing represents demand. The SOP is the forum in which the
production plan is developed.
Although the strategic business plan is updated annually, sales and operations
planning is a dynamic process in which the company plans are updated on a regular
basis, usually at least monthly. The process starts with the sales and marketing
departments, which compare actual demand with the sales plan, assess market potential, and forecast future demand. The updated marketing plan is then communicated
to manufacturing, engineering, and finance, which adjust their plans to support the
revised marketing plan. If these departments find they cannot accommodate the new
marketing plan, then the marketing plan must be adjusted. In this way the strategic
business plan is continually revised throughout the year and the activities of the various departments are coordinated. Figure 2.5 shows the relationship between the
strategic business plan and the sales and operations plan.
27
Production Planning System
ANNUAL
STRATEGIC
BUSINESS PLAN
MONTHLY
SALES AND OPERATIONS PLAN
MARKETING
PLAN
PRODUCTION
PLAN
DETAILED SALES
PLAN
MASTER
PRODUCTION
SCHEDULE
WEEKLY OR
DAILY
Figure 2.5 Sales and operations planning.
Sales and operations planning is medium range and includes the marketing,
production, engineering, and finance plans. Sales and operations planning has several
benefits:
• It provides a means of updating the strategic business plan as conditions
change.
• It provides a means of managing change. Rather than reacting to changes in
market conditions or the economy after they happen, the SOP forces management to look at the economy at least monthly and places it in a better position
to plan changes.
• Planning ensures the various department plans are realistic, coordinated, and
support the business plan.
• It provides a realistic plan that can achieve the company objectives.
• It permits better management of production, inventory, and backlog.
It is important to realize that effective sales and operations planning is an
executive-level planning process that involves the potential to make significant tradeoffs between the various functions/departments in the company. In this way those
28
Chapter 2
executives can ensure that the best approach to volume and mix are made and that
supply and demand are balanced in the best approach possible.
MANUFACTURING RESOURCE PLANNING
Because of the large amount of data and the number of calculations needed, the
manufacturing planning and control system will probably have to be computer
based. If a computer is not used, the time and labor required to make calculations
manually is extensive and forces a company into compromises. Instead of scheduling
requirements through the planning system, the company may have to extend lead
times and build inventory to compensate for the inability to schedule quickly what is
needed and when.
The system is intended to be a fully integrated planning and control system
that works from the top down and has feedback from the bottom up. Strategic business planning integrates the plans and activities of marketing, finance, and production to create plans intended to achieve the overall goals of the company. In turn,
master production scheduling, material requirements planning, production activity
control, and purchasing are directed toward achieving the goals of the production
and strategic business plans and, ultimately, the company. If priority plans have to be
adjusted at any of the planning levels because of capacity problems, those changes
should be reflected in the levels above. Thus, there must be feedback throughout the
system.
The strategic business plan incorporates the plans of marketing, finance, and production. Marketing must agree that its plans are realistic and attainable. Finance must
agree that the plans are desirable from a financial point of view, and production must
agree that it can meet the required demand. The manufacturing planning and control
system, as described here, is a master game plan for all departments in the company.
This fully integrated planning and control system is called a manufacturing resource
planning, or MRP II. system. The term MRP II is used to distinguish the “manufacturing resource plan” (MRP II) from the “materials requirement plan” (MRP).
MRP II provides coordination between marketing and production. Marketing,
finance, and production agree on a total workable plan expressed in the production
plan. Marketing and production must work together on a weekly and daily basis to
adjust the plan as changes occur. Order sizes may need to be changed, orders canceled, and delivery dates adjusted. This kind of change is made through the master
production schedule. Marketing managers and production managers may change
master production schedules to meet changes in forecast demand. Senior management may adjust the production plan to reflect overall changes in demand or
resources. However, they all work through the MRP II system. It provides the mechanism for coordinating the efforts of marketing, finance, production, and other
departments in the company. MRP II is a method for the effective planning of all
resources of a manufacturing company.
Figure 2.6 shows a diagram of an MRP II system. Note the feedback loops that exist.
29
Production Planning System
BUSINESS PLAN
RESOURCES OK?
No
MASTER SCHEDULE
SALES PLAN
MATERIAL REQUIREMENTS PLAN
RESOURCES OK?
No
Yes
PURCHASING
FEEDBACK
Closed-Loop MRP
Yes
FEEDBACK
SALES AND OPERATION PLAN
MARKETING
PRODUCTION
PLAN
PLAN
PRODUCTION
ACTIVITY
CONTROL
PERFORMANCE MEASURES
Figure 2.6 Manufacturing resource planning (MRP II).
ENTERPRISE RESOURCE PLANNING
As MRP systems evolved, they tended to take advantage of two changing conditions:
1. Computers and information technologies (IT) becoming significantly faster,
more reliable, and more powerful. People in most companies had become at
30
Chapter 2
least comfortable, but often very familiar, with the advantages in speed, accuracy, and capability of integrated computer-based management systems.
2. Movement toward integration of knowledge and decision making in all aspects
of direct and indirect functions and areas that impact materials flow and materials management. This integration not only included internal functions such as
marketing, engineering, human resources, accounting, and finance but also
included the “upstream” activities in supplier information and the “downstream” activities of distribution and delivery. That movement of integration is
what is now recognized as supply chain management.
As the needs of the organization grew in the direction of a truly integrated
approach toward materials management, the development of IT systems matched
that need. As these systems became both larger in scope and integration when compared to the existing MRP and MRP II systems, they were given a new name—
enterprise resource planning, or ERP.
ERP is similar to the MRP II system except it does not dwell on manufacturing.
The whole enterprise is taken into account. The eleventh edition of the American
Production and Inventory Control Society (APICS) APICS Dictionary defines ERP as
“Framework for organizing, defining, and standardizing the business processes necessary to effectively plan and control an organization so the organization can use its
internal knowledge to seek external advantage.” To fully operate there must be applications for planning, scheduling, costing, and so forth, to all layers in an organization,
work centers, sites, divisions, and corporate. Essentially, ERP encompasses the total
company and MRP II is manufacturing.
The larger scope of ERP systems allows the tracking of orders and other important planning and control information throughout the entire company from procurement to ultimate customer delivery. In addition, many ERP systems are capable of
allowing managers to share data between firms, meaning that these managers can
potentially have visibility across the complete span of the supply chain.
Although the power and capability of these highly integrated ERP systems is
extremely high, there are also some large costs involved. Many of the best systems are
expensive to buy, and the large data requirements (for both quantity and accuracy) tend
to make the systems expensive, time consuming, and generally difficult to implement for
many firms.
MAKING THE PRODUCTION PLAN
We have looked briefly at the purpose, planning horizon, and level of detail found in a
production plan. This section discusses some details involved in making production plans.
Based on the market plan and available resources, the production plan sets the
limits or levels of manufacturing activity for some time in the future. It integrates the
capabilities and capacity of the factory with the market and financial plans to achieve
the overall business goals of the company.
The production plan sets the general levels of production and inventories over
the planning horizon. Its prime purpose is to establish production rates that will
Production Planning System
31
accomplish the objectives of the strategic business plan. These include inventory levels,
backlogs (unfilled customer orders), market demand, customer service, low-cost
plant operation, labor relations, and so on. The plan must extend far enough in the
future to plan for the labor, equipment, facilities, and material needed to accomplish it.
Typically, this is a period of six to eighteen months and is done in monthly and sometimes weekly periods.
The planning process at this level ignores such details as individual products,
colors, styles, or options. With the time spans involved and the uncertainty of demand
over long periods, the detail would not be accurate or useful, and the plan would be
expensive to create. For planning purposes, a common unit or small number of product groups is what is needed.
Establishing Product Groups
Firms that make a single product, or products that are similar, can measure their output directly by the number of units they produce. A brewery, for instance, might use
barrels of beer as a common denominator. Many companies, however, make several
different products, and a common denominator for measuring total output may be
difficult or impossible to find. Product groups need to be established. Although marketing naturally looks at products from the customers’ point of view of functionality
and application, manufacturing looks at products in terms of processes. Thus, firms
need to establish product groups based on the similarity of manufacturing processes.
Manufacturing must provide the capacity to produce the goods needed. It is
concerned more with the demand for the specific kinds of capacity needed to make
the products than with the demand for the product.
Capacity is the ability to produce goods and services. It means having the
resources available to satisfy demand. For the time span of a production plan, it can
be expressed as the time available or, sometimes, as the number of units or dollars
that can be produced in a given period. The demand for goods must be translated
into the demand for capacity. At the production planning level, where little detail is
needed, this requires identifying product groups, or families, of individual products
based on the similarity of manufacturing process. For example, several calculator models might share the same processes and need the same kind of capacity, regardless of
the variations in the models. They would be considered as a family group of products.
Over the time span of the production plan, large changes in capacity are usually
not possible. Additions or subtractions in plant and equipment are impossible or very
difficult to accomplish in this period. However, some things can be altered, and it is
the responsibility of manufacturing management to identify and assess them. Usually
the following can be varied:
• People can be hired and laid off, overtime and short time can be worked, and
shifts can be added or removed.
• Inventory can be built up in slack periods and sold or used in periods of high
demand.
• Work can be subcontracted or extra equipment leased.
Chapter 2
Each alternative has its associated benefits and costs. Manufacturing management is responsible for finding the least-cost alternative consistent with the goals and
objectives of the business.
Basic Strategies
In summary, the production planning problem typically has the following characteristics:
• A time horizon of 12 months is used, with periodic updating perhaps every
month or quarter.
• Production demand consists of one or a few product families or common units.
• Demand is fluctuating or seasonal.
• Plant and equipment are fixed within the time horizon.
• A variety of management objectives are set, such as low inventories, efficient
plant operation, good customer service, and good labor relations.
Suppose a product group has the demand forecast shown in Figure 2.7. Note
that the demand is seasonal.
There are three basic strategies that can be used in developing a production
plan:
1. Chase strategy.
2. Production leveling.
3. Subcontracting.
Chase (demand matching) strategy. Chase strategy means producing the
amounts demanded at any given time. Inventory levels remain stable while production varies to meet demand. Figure 2.8 shows this strategy. The firm manufactures
Figure 2.7 Hypothetical
demand curve.
DEMAND
32
Demand
J
F
M
A
M
J
TIME
J
A
S
O
N
D
33
Production Planning System
DEMAND
Figure 2.8 Demand matching
strategy.
Demand
Production
J
F
M
A
M
J
J
A
S
O
N
D
TIME
just enough at any one time to meet demand exactly. In some industries, this is the
only strategy that can be followed. Farmers, for instance, must produce in the growing
season. The post office must process mail over the Christmas rush and in slack seasons. Restaurants have to serve meals when the customers want them. These industries cannot stockpile or inventory their products or services and must be capable of
meeting demand as it occurs.
In these cases, the company must have enough capacity to be able to meet the
peak demand. Farmers must have sufficient machinery and equipment to harvest in
the growing season although the equipment will lie idle in the winter. Companies
have to hire and train people for the peak periods and lay them off when the peak is
past. Sometimes they have to put on extra shifts and overtime. All these changes
add cost.
The advantage to the chase strategy is that inventories can be kept to a minimum. Goods are made when demand occurs and are not stockpiled. Thus, the costs
associated with carrying inventories are avoided. Such costs can be quite high, as is
shown in Chapter 9 on inventory fundamentals.
Production leveling. Production leveling is continually producing an amount
equal to the average demand. This relationship is shown in Figure 2.9. Companies
calculate their total demand over the time span of the plan and, on the average, produce enough to meet it. Sometimes demand is less than the amount produced and an
inventory builds up. At other times demand is greater and inventory is used up.
The advantage of a production leveling strategy is that it results in a smooth
level of operation that avoids the costs of changing production levels. Firms do not
need to have excess capacity to meet peak demand. They do not need to hire and
train workers and lay them off in slack periods. They can build a stable workforce.
The disadvantage is that inventory will build up in low-demand periods. This inventory will cost money to carry.
Production leveling means the company will use its resources at a level rate and
produce the same amount each day it is operating. The amount produced each month
Chapter 2
Figure 2.9 Production
leveling strategy.
DEMAND
34
Demand
Production
J
F
M
A
M
J
J
A
S
O
N
D
TIME
(or sometimes each week) will not be constant because the number of working days
varies from month to month.
EXAMPLE PROBLEM
A company wants to produce 10,000 units of an item over the next three months at a
level rate. The first month has 20 working days; the second, 21 working days; and the
third, 12 working days because of an annual shutdown. On the average, how much
should the company produce each day to level production?
Answer
Total production = 10,000 units
Total working days = 20 + 21 + 12 = 53 days
10,000
Average daily production =
= 188.7 units
53
For some products for which demand is very seasonal, such as Christmas tree lights,
some form of production leveling strategy is necessary. The costs of idle capacity—and of
hiring, training, and laying off—are severe if a company employs a chase strategy.
Subcontracting. As a pure strategy, subcontracting means always producing at
the level of minimum demand and meeting any additional demand through subcontracting. Subcontracting can mean buying the extra amounts demanded or turning
away extra demand. The latter can be done by increasing prices when demand is high
or by extending lead times. This strategy is shown in Figure 2.10.
The major advantage of this strategy is cost. Costs associated with excess capacity are avoided, and because production is leveled, there are no costs associated with
changing production levels. The main disadvantage is that the cost of purchasing
35
Production Planning System
DEMAND
Figure 2.10 Subcontracting.
Demand
Production
J
F
M
A
M
J
J
A
S
O
N
D
TIME
(item cost, purchasing, transportation, and inspection costs) may be greater than if
the item were made in the plant.
Few companies make everything or buy everything they need. The decision
about which items to buy and which to manufacture depends mainly on cost, but
there are several other factors that may be considered.
Firms may manufacture to keep confidential processes within the company, to
maintain quality levels, and to maintain a workforce.
They may buy from a supplier who has special expertise in design and manufacture of a component, to allow the firm to concentrate on its own area of expertise, or
to provide known and competitive prices.
For many items, such as nuts and bolts or components that the firm does not
normally make, the decision is clear. For other items that are within the specialty of
the firm, a decision must be made whether to subcontract or not.
Hybrid strategy. The three strategies discussed so far are pure strategies. Each
has its own set of costs: equipment, hiring/layoff, overtime, inventory, and subcontracting. In reality, there are many possible hybrid or combined strategies a company
may use. Each will have its own set of cost characteristics. Production management is
responsible for finding the combination of strategies that minimizes the sum of all
costs involved, providing the level of service required, and meeting the objectives of
the financial and marketing plans.
Figure 2.11 shows a possible hybrid plan. Demand is matched to some extent,
production is partially smoothed, and in the peak period some subcontracting takes
place. The plan is only one of many that could be developed.
Developing a Make-to-Stock Production Plan
In a make-to-stock environment, products are made and put into inventory before an
order is received from a customer. Sale and delivery of the goods are made from
inventory. Off-the-rack clothing, frozen foods, and bicycles are examples of this kind
of manufacturing.
Chapter 2
Figure 2.11 Hybrid strategy.
DEMAND
36
Demand
Production
J
F
M
A
M
J
J
A
S
O
N
D
TIME
Generally firms make to stock when:
• Demand is fairly constant and predictable.
• There are few product options.
• Delivery times demanded by the marketplace are much shorter than the time
needed to make the product.
• Product has a long shelf life.
The information needed to make a production plan is as follows:
•
•
•
•
Forecast by period for the planning horizon.
Opening inventory.
Desired ending inventory.
Any past-due customer orders. These are orders that are late for delivery and
are sometimes called back orders.
The objective in developing a production plan is to minimize the costs of carrying inventory, changing production levels, and stocking out (not supplying the customer what is wanted when it is wanted).
This section develops a plan for leveling production and one for chase strategy.
Level production plan. Following is the general procedure for developing a plan
for level production.
1. Total the forecast demand for the planning horizon.
2. Determine the opening inventory and the desired ending inventory.
3. Calculate the total production required as follows:
Total Production = total forecast + back orders
+ ending inventory - opening inventory
37
Production Planning System
4. Calculate the production required each period by dividing the total production
by the number of periods.
5. Calculate the ending inventory for each period.
EXAMPLE PROBLEM
Amalgamated Fish Sinkers makes a product group of fresh fish sinkers and wants to
develop a production plan for them. The expected opening inventory is 100 cases, and
the company wants to reduce that to 80 cases by the end of the planning period. The
number of working days is the same for each period. There are no back orders. The
expected demand for the fish sinkers is as follows:
Period
Forecast (cases)
1
2
3
4
5
Total
110
120
130
120
120
600
a. How much should be produced each period?
b. What is the ending inventory for each period?
c. If the cost of carrying inventory is $5 per case per period based on ending inventory, what is the total cost of carrying inventory?
d. What will be the total cost of the plan?
Answer
a. Total production required = 600 + 80 - 100 = 580 cases
580
Production each period =
= 116 cases
5
b. Ending inventory = opening inventory + production - demand
Ending inventory after the first period = 100 + 116 - 110 = 106 cases
Similarly, the ending inventories for each period are calculated as shown in
Figure 2.12. The ending inventory for period 1 becomes the opening inventory for
period 2:
Ending inventory (period 2) = 106 + 116 - 120 = 102 cases
c. The total cost of carrying inventory would be:
1106 + 102 + 88 + 84 + 8021$52 = $2300
d. Since there were no stockouts and no changes in the level of production, this
would be the total cost of the plan.
38
Chapter 2
Period
1
2
3
4
5
Forecast (cases)
110
120
130
120
120
600
Production
116
116
116
116
116
580
106
102
88
84
80
Ending
Inventory
100
Total
Figure 2.12 Level production plan: make to stock.
Chase strategy. Amalgamated Fish Sinkers makes another line of product called
“fish stinkers.” Unfortunately, they are perishable, and the company cannot build
inventory for sale later. They must use a chase strategy and make only enough to satisfy
demand in each period. Inventory costs will be a minimum, and there should be no
stockout costs. However, there will be costs associated with changing production levels.
Let us suppose in the preceding example that changing the production level by
one case costs $20. For example, a change from 50 to 60 would cost
160 - 502 * $20 = $200
The opening inventory is 100 cases, and the company wishes to bring this down to
80 cases in the first period. The required production in the first period would then be:
110 - 1100 - 802 = 90 cases
Assuming that production in the period before period 1 was 100 cases, Figure 2.13
shows the changes in production levels and in ending inventory.
Period
0
Demand
(cases)
Production
100
Change in
Production
Ending
Inventory
100
1
2
3
4
5
Total
110
120
130
120
120
600
90
120
130
120
120
580
10
30
10
10
0
60
80
80
80
80
80
Figure 2.13 Demand making plan: make to stock.
Production Planning System
39
The cost of the plan would be:
Cost of changing production level = 16021$202 = $1200
Cost of carrying inventory = 180 cases215 periods21$52 = $2000
Total cost of the plan = $1200 + $2000 = $3200
Developing a Make-to-Order Production Plan
In a make-to-order environment, manufacturers wait until an order is received from a
customer before starting to make the goods. Examples of this kind of manufacture are
custom-tailored clothing, machinery, or any product made to customer specification.
Very expensive items are usually made to order. Generally, firms make to order when:
•
•
•
•
Goods are produced to customer specification.
The customer is willing to wait while the order is being made.
The product is expensive to make and to store.
Several product options are offered.
Assemble to order. Where several product options exist, such as in automobiles,
and where the customer is not willing to wait until the product is made, manufacturers produce and stock standard component parts. When manufacturers receive an
order from a customer, they assemble the component parts from inventory according
to the order. Since the components are stocked, the firm needs only time to assemble
before delivering to the customer. Examples of assemble-to-order products include
automobiles and computers. Assemble to order is a subset of make to order.
The following information is needed to make a production plan for make-toorder products:
• Forecast by period for the planning horizon.
• Opening backlog of customer orders.
• Desired ending backlog.
Backlog. In a make-to-order environment, a company does not build an inventory
of finished goods. Instead, it has a backlog of unfilled customer orders. The backlog
normally will be for delivery in the future and does not represent orders that are late
or past due. A custom woodwork shop might have orders from customers that will
keep it busy for several weeks. This will be its backlog. If individuals want some work
done, the order will join the queue or backlog. Manufacturers like to control the
backlog so that they can provide a good level of customer service.
Level production plan. Following is a general procedure for developing a maketo-order level production plan:
1. Total the forecast demand for the planning horizon.
2. Determine the opening backlog and the desired ending backlog.
40
Chapter 2
3. Calculate the total production required as follows:
Total production = total forecast + opening backlog - ending backlog
4. Calculate the production required each period by dividing the total production
by the number of periods.
5. Spread the existing backlog over the planning horizon according to due date per
period.
EXAMPLE PROBLEM
A local printing company provides a custom printing service. Since each job is different, demand is forecast in hours per week. Over the next 5 weeks, the company
expects that demand will be 100 hours per week. There is an existing backlog of 100
hours, and at the end of 5 weeks, the company wants to reduce that to 80 hours. How
many hours of work will be needed each week to reduce the backlog? What will be
the backlog at the end of each week?
Answer
Total production = 500 + 100 - 80 = 520 hours
520
Weekly production =
= 104 hours
5
The backlog for each week can be calculated as:
For week 1:
For week 2:
Projected backlog = old backlog + forecast - production
Projected backlog = 100 + 100 - 104 = 96 hours
Projected backlog = 96 + 100 - 104 = 92 hours
Figure 2.14 shows the resulting production plan.
Period
1
2
3
4
5
Total
Sales Forecast
100
100
100
100
100
500
Planned Production
104
104
104
104
104
520
Projected
Backlog
96
92
88
84
80
100
Figure 2.14 Level production plan: make to order.
41
Production Planning System
Resource Planning
Once the preliminary production plan is established, it must be compared to the
existing resources of the company. This step is called resource requirements planning
or resource planning. Two questions must be answered:
1. Are the resources available to meet the production plan?
2. If not, how will the difference be reconciled?
If enough capacity to meet the production plan cannot be made available, the
plan must be changed.
A tool often used is the resource bill. This shows the quantity of critical
resources (materials, labor, and “bottleneck” operations) needed to make one average unit of the product group. Figure 2.15 shows an example of a resource bill for a
company that makes tables, chairs, and stools as a three-product family.
If the firm planned to make 500 tables, 300 chairs, and 1500 stools in a particular period, they could calculate the quantity of wood and labor that will be needed.
For example, the amount of wood needed is:
Tables:
Chairs:
500 * 20 = 10,000 board feet
300 * 10 = 3000 board feet
Stools:
1500 * 5 = 7500 board feet
Total wood required = 20,500 board feet
The amount of labor needed is:
Tables:
500 * 1.31
Chairs:
300 * 0.85
Stools:
1500 * 0.55
Total labor required
=
=
=
=
655 standard hours
255 standard hours
825 standard hours
1735 standard hours
The company must now compare the requirements for wood and labor with the
availability of these resources. For instance, suppose the labor normally available in this
period is 1600 hours. The priority plan requires 1735 hours, a difference of 135 hours, or
about 8.4%. Extra capacity must be found, or the priority plan must be adjusted. In this
example, it might be possible to work overtime to provide the extra capacity required.
Figure 2.15 Resource bill.
Product
Wood
(board
feet)
Labor
(standard
hours)
Tables
Chairs
Stools
20
10
5
1.31
0.85
0.55
42
Chapter 2
If overtime is not possible, the plan must be adjusted to reduce the labor needed. This
might involve shifting some production to an earlier period or delaying shipments.
SUMMARY
Production planning is the first step in a manufacturing planning and control system.
The planning horizon usually extends for a year. The minimum horizon depends on
the lead times to purchase materials and make the product. The level of detail is not
high. Usually, the plan is made for families of products based on the similarity of
manufacturing process or on some common unit. The production plan is part of the
Sales and Operations Planning process, which is an executive-level planning process
involving trade-offs across departments or functions in the company.
Three basic strategies can be used to develop a production plan: chase, leveling
production, or subcontracting. Each has its operational and cost advantages and disadvantages. It is the responsibility of manufacturing management to select the best
combination of these basic plans so total costs are minimized and customer service
levels are maintained.
A make-to-stock production plan determines how much to produce in each
period to meet the following objectives:
• Achieve the forecast.
• Maintain the required inventory levels.
Although demand must be satisfied, the plan must balance the costs of maintaining inventory with the cost of changing production levels.
A make-to-order production plan determines how much to produce in each
period to meet the following objectives:
• Achieve the forecast.
• Maintain the planned backlog.
The cost of a backlog that is too large equals the cost of turning away business.
If customers have to wait too long for delivery, they might take their business elsewhere. As with a make-to-stock production plan, demand must be satisfied, and the
plan must balance the costs of changing production levels with the cost of a backlog
that is larger than desired.
KEY TERMS
Priority 20
Capacity 21
Sales and operations
planning (SOP) 24
Manufacturing resource
planning (MRP II) 28
Enterprise resource planning
(ERP) 30
Chase strategy 32
Production leveling 33
Subcontracting 34
Hybrid 35
Level production plan 36
Backlog 39
Resource bill 41
Production Planning System
43
QUESTIONS
1. What are the four questions a good planning system must answer?
2. Define capacity and priority. Why are they important in production planning?
3. Describe each of the following plans in terms of their purpose, planning horizon, level of
detail, and planning cycle:
a. Strategic business plan.
b. Production plan.
c. Master production schedule.
d. Material requirements plan.
e. Production activity control.
4. Describe the responsibilities and inputs of the marketing, production, finance, and engineering departments to the strategic business plan.
5. Describe the relationship among the production plan, the master production schedule,
and the material requirements plan.
6. What is the difference between strategic business planning and sales and operations
planning (SOP)? What are the major benefits of SOP?
7. What is closed-loop MRP?
8. What is MRP II?
9. What two changing conditions led to the development of ERP systems?
10. In the short run, how can capacity be changed?
11. When making a production plan, why is it necessary to select a common unit or to establish product families?
12. On what basis should product groups (families) be established?
13. What are five typical characteristics of the production planning problem?
14. Describe each of the three basic strategies used in developing a production plan. What
are the advantages and disadvantages of each?
15. What is a hybrid strategy? Why is it used?
16. Describe four conditions under which a firm would make to stock or make to order.
17. What information is needed to develop a make-to-stock production plan?
18. What are the steps in developing a make-to-stock production plan?
19. What is the difference between make to order and assemble to order? Give an example
of each.
20. What information is needed to develop a make-to-order production plan? How does this
differ from that needed for a make-to-stock plan?
21. What is the general procedure for developing a level production plan in a make-to-order
environment?
22. What is a resource bill? At what level in the planning hierarchy is it used?
23. What kind of production environment would you expect to see if a company uses a chase
strategy? What if it uses a level strategy?
44
Chapter 2
PROBLEMS
2.1
2.2
2.3
2.4
2.5
2.6
If the opening inventory is 400 units, demand is 900 units, and production is 800 units,
what will be the ending inventory?
Answer.
300 units
A company wants to produce 500 units over the next 3 months at a level rate. The
months have 19, 20, and 21 working days, respectively. On the average, how much should
the company produce each day to level production?
Answer.
Average daily production = 8.3 units
A company plans to produce 20,000 units in a 3-month period. The months have 22, 21,
and 20 working days respectively. What should the average daily production be?
In problem 2.2, how much will be produced in each of the 3 months?
Answer.
Month 1: 158
Month 2: 166
Month 3: 174
In problem 2.3, how much will be produced in each of the 3 months?
A production line is to run at 1000 units per month. Sales are forecast as shown in the
following. Calculate the expected period-end inventory. The opening inventory is
500 units. All periods have the same number of working days.
Period
1
2
3
4
5
6
Forecast
700
700
1100
1600
1100
800
Planned Production
1000
1000
1000
1000
1000
1000
Planned
Inventory
500
Answer.
For period 1, the ending inventory is 800 units.
2.7 A company wants to develop a level production plan for a family of products. The opening inventory is 100 units, and an increase to 160 units is expected by the end of the plan.
The demand for each period is given in what follows. How much should the company
produce each period? What will be the ending inventories in each period? All periods
have the same number of working days.
Period
Forecast Demand
Planned Production
Planned
Inventory
100
1
2
3
4
5
6
100
120
130
140
120
110
Total
45
Production Planning System
Total production = 780 units
Answer.
Period production = 130 units
The ending inventory for period 1 is 130; for period 5, 140.
2.8 A company wants to develop a level production plan for a family of products. The opening inventory is 500 units, and a decrease to 300 units is expected by the end of the plan.
The demand for each of the periods is given in what follows. All periods have the same
number of working days. How much should the company produce each period? What
will be the ending inventories in each period? Do you see any problems with the plan?
Period
Forecast Demand
1
2
3
4
5
6
1300
1200
800
600
800
1000
Total
Planned Production
Planned
Inventory
2.9
500
A company wants to develop a level production plan. The beginning inventory is zero.
Demand for the next four periods is given in what follows.
a. What production rate per period will give a zero inventory at the end of period 4?
b. When and in what quantities will back orders occur?
c. What level production rate per period will avoid back orders? What will be the ending inventory in period 4?
Period
1
2
3
4
Forecast Demand
9
5
9
9
Total
Planned Production
Planned Inventory
Answer.
0
a. 8 units
b. period 1, minus 1
c. 9 units; 4 units
2.10 If the cost of carrying inventory is $50 per unit per period and stockouts cost $500 per
unit, what will be the cost of the plan developed in problem 2.9a? What will be the cost
of the plan developed in 2.9c?
Answer.
Total cost for plan in question 2.9a = $650
Total cost for plan in question 2.9c = $600
46
Chapter 2
2.11 A company wants to develop a level production plan for a family of products. The opening inventory is 100 units, and an increase to 130 units is expected by the end of the plan.
The demand for each month is given in what follows. Calculate the total production,
daily production, and production and ending inventory for each month.
Month
May
Jun
Jul
Aug
Working Days
21
19
20
10
Forecast Demand
115
125
140
150
Total
Planned Production
Planned Inventory
100
Total monthly production for May = 168 units
Answer.
The ending inventory for May = 153 units
2.12 A company wants to develop a level production plan for a family of products. The opening inventory is 600 units, and a decrease to 200 units is expected by the end of the plan.
The demand for each of the months is given in what follows. How much should the company produce each month? What will be the ending inventory in each month? Do you
see any problems with the plan?
Month
Jan
Feb
Mar
Apr
May
Jun
Working Days
20
22
20
20
18
19
1200
1300
800
700
700
900
Forecast Demand
Total
Planned Production
Planned
Inventory
600
2.13 Because of its labor contract, a company must hire enough labor for 100 units of production per week on one shift or 200 units per week on two shifts. It cannot hire, lay off, or
assign overtime. During the fourth week, workers will be available from another department to work part or all of an extra shift (up to 100 units). There is a planned shutdown
for maintenance in the second week, which will cut production to half. Develop a
production plan. The opening inventory is 200 units, and the desired ending inventory is
300 units.
47
Production Planning System
Week
Forecast Demand
1
2
3
4
5
6
120
160
240
240
160
160
Total
Planned Production
Planned
Inventory
2.14 If the opening backlog is 500 units, forecast demand is 700 units, and production is 800
units, what will be the ending backlog?
Answer.
400 units
2.15 The opening backlog is 900 units. Forecast demand is shown in the following. Calculate
the weekly production for level production if the backlog is to be reduced to 200 units.
Week
Forecast Demand
1
2
3
4
5
6
600
700
700
700
600
500
Total
Planned Production
Projected
Backlog
900
Total production = 4500 units
Answer.
Weekly production = 750 units
Backlog at end of week 1 = 750 units
2.16 The opening backlog is 1100 units. Forecast demand is shown in the following. Calculate
the weekly production for level production if the backlog is to be increased to 1200 units.
Week
Forecast Demand
Planned Production
Projected
Backlog
1100
1
2
3
4
5
6
1200
1100
1200
1200
1100
1000
Total
48
Chapter 2
2.17 For the following data, calculate the number of workers required for level production
and the resulting month-end inventories. Each worker can produce 14 units per day, and
the desired ending inventory is 9000 units.
Month
1
2
3
4
Working Days
20
24
12
19
28,000
27,500
28,500
28,500
Forecast Demand
Total
Planned Production
Planned Inventory
11,500
Workers needed = 105 workers
Answer.
First month’s ending inventory = 12,900 units
2.18 For the following data, calculate the number of workers required for level production
and the resulting month-end inventories. Each worker can produce 9 units per day, and
the desired ending inventory is 800 units. Why is it not possible to reach the ending
inventory target?
Month
1
2
3
4
5
6
Working Days
20
24
12
22
20
19
2800
3000
2700
3300
2900
3200
Forecast Demand
Planned Production
Planned
Inventory
1000
Total
3
Master Scheduling
INTRODUCTION
After production planning, the next step in the manufacturing planning and control
process is to prepare a master production schedule (MPS). This chapter examines
some basic considerations in making and managing an MPS. It is an extremely important planning tool and forms the basis for communication between sales and manufacturing. The MPS is a vital link in the production planning system:
• It forms the link between production planning and what manufacturing will
actually build.
• It forms the basis for calculating the capacity and resources needed.
• The MPS drives the material requirements plan. As a schedule of items to be
built, the MPS and bills of material determine what components are needed
from manufacturing and purchasing.
• It keeps priorities valid. The MPS is a priority plan for manufacturing.
Whereas the production plan deals in families of products, the MPS works with
end items. It breaks down the production plan into the requirements for individual
end items, in each family, by date and quantity. The production plan limits the MPS.
Therefore the total of the items in the MPS should not be different from the total
shown on the production plan. For example, if the production plan shows a planned
production of 1000 tricycles in a particular week, the total of the individual models
49
50
Chapter 3
planned for by the MPS should be 1000. Within this limit, its objective is to balance
the demand (priorities) set by the marketplace with the availability of materials,
labor, and equipment (capacity) of manufacturing.
The end items made by the company are assembled from component and subcomponent parts. These must be available in the right quantities at the right time to
support the master production schedule. The material requirements planning system
plans the schedule for these components based on the needs of the MPS. Thus the
MPS drives the material requirements plan.
The MPS is a plan for manufacturing. It reflects the needs of the marketplace and
the capacity of manufacturing and forms a priority plan for manufacturing to follow.
The MPS forms a vital link between sales and production as follows:
• It makes possible valid order promises. The MPS is a plan of what is to be produced and when. As such, it tells sales and manufacturing when goods will be
available for delivery.
• It is a contract between marketing and manufacturing. It is an agreed-upon plan.
The MPS forms a basis for sales and production to determine what is to be
manufactured. It is not meant to be rigid. It is a device for communication and a basis
to make changes that are consistent with the demands of the marketplace and the
capacity of manufacturing.
The information needed to develop an MPS is provided by:
•
•
•
•
•
The production plan.
Forecasts for individual end items.
Actual orders received from customers and for stock replenishment.
Inventory levels for individual end items.
Capacity restraints.
RELATIONSHIP TO PRODUCTION PLAN
Suppose the following production plan is developed for a family of three items:
Week
1
2
3
4
5
6
Aggregate Forecast (units)
160
160
160
160
215
250
Production Plan
205
205
205
205
205
205
Aggregate Inventory (units)
545
590
635
680
670
625
51
Master Scheduling
Opening inventories (units) are:
Product A
Product B
Product C
Total
350
100
50
500
The next step is to forecast demand for each item in the product family.
Week
1
2
3
4
5
6
Product A
70
70
70
70
70
80
Product B
40
40
40
40
95
120
Product C
50
50
50
50
50
50
Total
160
160
160
160
215
250
With these data, the master scheduler must now devise a plan to fit the constraints. The following illustrates a possible solution.
Master Schedule
Week
1
2
3
4
5
Product A
Product B
205
205
205
205
Product C
Total Planned
6
205
205
205
205
205
205
205
205
1
2
3
4
5
6
Product A
280
210
140
70
0
125
Product B
265
430
595
555
460
340
Product C
0
–50
–100
55
210
160
545
640
735
680
670
625
Inventory
Week
Total Planned
52
Chapter 3
This schedule is satisfactory for the following reasons:
• It tells the plant when to start and stop production of individual items.
• Capacity is consistent with the production plan.
It is unsatisfactory for the following reasons:
• It has a poor inventory balance compared to total inventory.
• It results in a stockout for product C in periods 2 and 3.
The term master production schedule refers to the last line of the matrix. The
term master schedule refers to the process of arriving at that line. Thus the total matrix
is called a master schedule.
EXAMPLE PROBLEM
The Hotshot Lightning Rod Company makes a family of two lightning rods, Models
H and I. It bases its production planning on weeks. For the present month, production is leveled at 1000 units. Opening inventory is 500 units, and the plan is to reduce
that to 300 units by the end of the month. The MPS is made using weekly periods.
There are 4 weeks in this month, and production is to be leveled at 250 units per
week. The forecast and projected available for the two lightning rods follows.
Calculate an MPS for each item.
Answer
Production Plan
Week
Forecast
Projected Available
500
Production Plan
1
2
3
4
Total
300
350
300
250
1200
450
350
300
300
250
250
250
250
1000
1
2
3
4
Total
200
300
100
100
700
250
200
100
100
250
250
Master Schedule: Model H
Week
Forecast
Projected Available
MPS
200
100
53
Master Scheduling
Master Schedule: Model I
Week
Forecast
Projected Available
300
1
2
3
4
Total
100
50
200
150
500
200
150
200
200
250
150
MPS
DEVELOPING A MASTER PRODUCTION SCHEDULE
The objectives in developing an MPS are as follows:
• To maintain the desired level of customer service by maintaining finished-goods
inventory levels or by scheduling to meet customer delivery requirements.
• To make the best use of material, labor, and equipment.
• To maintain inventory investment at the required levels.
To reach these objectives, the plan must satisfy customer demand, be within the
capacity of manufacturing, and be within the guidelines of the production plan.
There are three steps in preparing an MPS:
1. Develop a preliminary MPS.
2. Check the preliminary MPS against available capacity.
3. Resolve differences between the preliminary MPS and capacity availability.
Preliminary Master Production Schedule
To show the process of developing an MPS, an example is used that assumes the
product is made to stock, an inventory is kept, and the product is made in lots.
A particular item is made in lots of 100, and the expected opening inventory is
80 units. Figure 3.1 shows the forecast of demand, the projected available on hand,
and the preliminary MPS.
Period 1 begins with an inventory of 80 units. After the forecast demand for
60 units is satisfied, the projected available is 20 units. A further forecast demand of 60
in period 2 is not satisfied, and it is necessary to schedule an MPS receipt of 100 for
week 2. This produces a projected available of 60 units 120 + 100 - 60 = 602 at the
end of period 2. In period 3, the forecast demand for 60 is satisfied by the projected 60
54
Chapter 3
On hand = 80 units
Lot size = 100 units
Period
1
2
3
4
5
6
Forecast
60
60
60
60
60
60
20
60
0
40
80
20
100
100
Projected Available
80
MPS
100
Figure 3.1 MPS example.
on hand, leaving a projected available of 0. In period 4, a further 100 must be received,
and when the forecast demand of 60 units is satisfied, 40 units remain in inventory.
This process of building an MPS occurs for each item in the family. If the total
planned production of all the items in the family and the total ending inventory do
not agree with the production plan, some adjustment to the individual plans must be
made so the total production is the same.
Once the preliminary master production schedules are made, they must be
checked against the available capacity. This process is called rough-cut capacity
planning.
EXAMPLE PROBLEM
Amalgamated Nut Crackers, Inc., makes a family of nut crackers. The most popular model is the walnut, and the sales department has prepared a 6-week
forecast. The opening inventory is 50 dozen (dozen is the unit used for planning).
As master planner, you must prepare an MPS. The nutcrackers are made in lots of
100 dozen.
Answer
Week
1
2
3
4
5
6
Forecast Sales
75
50
30
40
70
20
75
25
95
55
85
65
Projected Available
MPS
50
100
100
100
55
Master Scheduling
Rough-Cut Capacity Planning
Rough-cut capacity planning checks whether critical resources are available to support the preliminary master production schedules. Critical resources include bottleneck operations, labor, and critical materials (perhaps material that is scarce or has a
long lead time).
The process is similar to resource requirements planning used in the production planning process. The difference is that now we are working with a product
and not a family of products. The resource bill, used in resource requirements
planning, assumes a typical product in the family. Here the resource bill is for a
single product. As before, the only interest is in bottleneck work centers and critical resources.
Suppose a firm manufactures four models of desktop computers assembled in a
work center that is a bottleneck operation. The company wants to schedule to the
capacity of this work center and not beyond. Figure 3.2 is a resource bill for that work
center showing the time required to assemble one computer.
Suppose that in a particular week the master production schedules show the
following computers are to be built:
Model D24
Model D25
Model D26
Model D27
200 units
250 units
400 units
100 units
The capacity required on this critical resource is:
Model D24 200 * 0.203 = 40.6 standard hours
Model D25 250 * 0.300 = 75.0 standard hours
Model D26 400 * 0.350 = 140.0 standard hours
Model D27 100 * 0.425 = 42.5 standard hours
Total time required = 298.1 standard hours
Figure 3.2 Resource bill.
Resource Bill
Desktop Computer Assembly
Computer
Assembly Time
(standard hours)
Model D24
Model D25
Model D26
Model D27
0.203
0.300
0.350
0.425
56
Chapter 3
EXAMPLE PROBLEM
The Acme Tweezers Company makes tweezers in two models, medium and fine. The
bottleneck operation is in work center 20. Following is the resource bill (in hours per
dozen) for work center 20.
Hours per Dozen
Work Center
Medium
Fine
20
0.5
1.2
The master production schedule for the next 4 weeks is:
Week
1
2
3
4
Total
Medium
40
25
40
15
120
Fine
20
10
30
20
80
Using the resource bill and the master production schedule, calculate the number of
hours required in work center 20 for each of the 4 weeks. Use the following table to
record the required capacity on the work center.
Answer
Week
1
2
3
4
Total
Medium
20
12.5
20
7.5
60
Fine
24
12
36
24
96
Total Hours
44
24.5
56
31.5
156
Resolution of Differences
The next step is to compare the total time required to the available capacity of the
work center. If available capacity is greater than the required capacity, the MPS is
workable. If not, methods of increasing capacity have to be investigated. Is it possible
to adjust the available capacity with overtime, extra workers, routing through other
Master Scheduling
57
work centers, or subcontracting? If not, it will be necessary to revise the master production schedule.
Finally, the master production schedule must be judged by three criteria:
1. Resource use. Is the MPS within capacity restraints in each period of the plan?
Does it make the best use of resources?
2. Customer service. Will due dates be met and will delivery performance be
acceptable?
3. Cost. Is the plan economical, or will excess costs be incurred for overtime, subcontracting, expediting, or transportation?
Master Schedule Decisions
The MPS should represent as efficiently as possible what manufacturing will make. If
too many items are included, it will lead to difficulties in forecasting and managing
the MPS. In each of the manufacturing environments—make to stock, make to order,
and assemble to order—master scheduling should take place where the smallest
number of product options exists. Figure 3.3 shows the level at which items should be
master scheduled.
Make-to-stock products. In this environment, a limited number of standard
items are assembled from many components. Televisions and other consumer products are examples. The MPS is usually a schedule of finished-goods items.
Make-to-order products. In this environment, many different end items are
made from a small number of components. Custom-tailored clothes are an example.
The MPS is usually a schedule of the actual customer orders.
Assemble-to-order products. In this environment, many end items can be made
from combinations of basic components and subassemblies. For example, suppose a
company manufactures paint from a base color and adds tints to arrive at the final
color. Suppose there are 10 tints and a final color is made by mixing any three of them
with the base. There are 720 possible colors 110 * 9 * 8 = 7202. Forecasting and
planning production for 720 items is a difficult task. It is much easier if production is
planned at the level of the base color and the 10 tints. There are then only 10 items
with which to deal: the base color and each of the 10 tints. Once a customer’s order is
received, the base color and the required tints can be combined (assembled) according to the order.
Final assembly schedule (FAS). This last step, assembly to customer order, is
generally planned using a final assembly schedule. This is a schedule of what will be
assembled. It is used when there are many options and it is difficult to forecast which
combination the customers will want. Master production scheduling is done at the
component level, for example, the base color and tint level. The final assembly takes
place only when a customer order is received.
58
Chapter 3
Make to
Stock
End
Product
Make to
Order
MPS
Assemble to
Order
End
Product
FAS
End
Product
FAS
MPS
MPS
Raw
Material
Raw
Material
Raw
Material
Figure 3.3 Different MPS environments.
The FAS schedules customer orders as they are received and is based on the
components planned in the MPS. It is responsible for scheduling from the MPS
through final assembly and shipment to the customer.
ORDER ENTRY
AND
PROMISE
PRODUCTION
PLAN
RESOURCE
REQUIREMENTS
PLAN
LONG RANGE
FINAL
ASSEMBLY
SCHEDULE
MASTER
PRODUCTION
SCHEDULE
ROUGH CUT
CAPACITY
PLAN
MEDIUM RANGE
MATERIAL
REQUIREMENTS
PLAN
CAPACITY
REQUIREMENTS
PLAN
SHORT RANGE
PURCHASING
AND
PRODUCTION
ACTIVITY
CONTROL
INPUT/OUTPUT
CONTROL
AND
OPERATION
SEQUENCING
IMMEDIATE
RANGE
Figure 3.4 MPS, FAS, and other planning activities.
59
Master Scheduling
Engineer to order. This is a form of make-to-order (MTO) products. In this environment, the product is designed before manufacturing based on the customer’s very
special needs. A bridge is an example.
Figure 3.4 shows the relationship of the MPS, the FAS, and other planning
activities.
Planning Horizon
The planning horizon is the time span for which plans are made. It must cover a
period at least equal to the time required to accomplish the plan. For master production scheduling, the minimum planning horizon is the longest cumulative or end-toend lead time (LT). For example, in Figure 3.5, the longest cumulative lead time path
is A to D to F to G. The cumulative lead time is 1 + 2 + 3 + 6 = 12 weeks. The
minimum planning horizon must be 12 weeks; otherwise, raw material G is not
ordered in time to meet delivery.
The planning horizon is usually longer for several reasons. The longer the horizon, the greater the “visibility” and the better management’s ability to avoid future
problems or to take advantage of special circumstances. For example, firms might
take advantage of economical purchase plans, avoid future capacity problems, or
manufacture in more economical lot sizes.
As a minimum, the planning horizon for a final assembly schedule must include
time to assemble a customer’s order. It does not need to include the time necessary to
manufacture the components. That time will be included in the planning horizon of
the MPS.
Figure 3.5 Product structure:
critical lead time.
B
(LT=6)
A
(LT=1)
C
(LT=5)
E
D
(LT=2)
F
(LT=3)
G (LT=6)
60
Chapter 3
PRODUCTION PLANNING, MASTER SCHEDULING, AND SALES
The production plan reconciles total forecast demand with available resources. It
takes information from the strategic business plan and market forecasts to produce
an overall plan of what production intends to make to meet forecast. It is dependent
on the forecast and, within capacity limits, must plan to satisfy the forecast demand. It
is not concerned with the detail of what will actually be made. It is intended to provide a framework in which detailed plans can be made in the MPS.
The MPS is built from forecasts and actual demands for individual end items. It
reconciles demand with the production plan and with available resources to produce
a plan that manufacturing can fulfill. The MPS is concerned with what items will actually be built, in what quantities, and when, to meet expected demand.
The production plan and the MPS uncouple the sales forecast from manufacturing by establishing a manufacturing plan. Together, they attempt to balance available resources of plant, equipment, labor, and material with forecast demand.
However, they are not a sales forecast, nor are they necessarily what is desired. The
MPS is a plan for what production can and will do.
Figure 3.6 shows the relationship between the sales forecast, production plan,
and MPS.
The MPS must be realistic about what manufacturing can and will do. If it is
not, it will result in overloaded capacity plans, past-due schedules, unreliable delivery
promises, surges in shipments, and lack of accountability.
The MPS is a plan for specific end items or “buildable” components that manufacturing expects to make over some time in the future. It is the point at which manufacturing and marketing must agree what end items are going to be produced. Manufacturing
is committed to making the goods; marketing, to selling the goods. However, the MPS is
not meant to be rigid. Demand changes, problems occur in production, and, sometimes,
components are scarce. These events may make it necessary to alter the MPS. Changes
must be made with the full understanding and agreement of sales and production. The
MPS provides the basis for making changes and a plan on which all can agree.
SALES
FORECAST
PRODUCTION
PLAN
MASTER
PRODUCTION
SCHEDULE
MATERIAL
REQUIREMENTS
PLAN
Figure 3.6 Sales forecast, production plan, and master production schedule.
61
Master Scheduling
The MPS and Delivery Promises
In a make-to-stock environment, customer orders are satisfied from inventory.
However, in make-to-order or assemble-to-order environments, demand is satisfied
from production capacity. In either case, sales and distribution need to know what is
available to satisfy customer demand. Since demand can be satisfied either from
inventory or from scheduled receipts, the MPS provides a plan for doing either.
Figure 3.7 illustrates the concept. As orders are received, they “consume” the available inventory or capacity. Any part of the plan that is not consumed by actual customer orders is available to promise to customers. In this way, the MPS provides a
realistic basis for making delivery promises.
Using the MPS, sales and distribution can determine the available to promise
(ATP). Available to promise is that portion of a firm’s inventory and planned production that is not already committed and is available to the customer. This allows
delivery promises to be made and customer orders and deliveries to be scheduled
accurately.
The ATP is calculated by adding scheduled receipts to the beginning inventory
and then subtracting actual orders scheduled before the next scheduled receipt.
A scheduled receipt is an order that has been issued either to manufacturing or to a
supplier. Figure 3.8 illustrates a calculation of an ATP:
ATP for period 1 = on hand - customer orders due before next MPS
= 100 - 80
= 20 units
ATP for period 2 MPS scheduled receipt customer orders due before
next MPS
= 100 - 110 + 102
= 80 units
ATP for period 4 = 100 - 30 = 70 units
This method assumes that the ATP will be sold before the next scheduled
receipt arrives. It is there to be sold, and the assumption is that it will be sold. If it is
not sold, whatever is left forms an on-hand balance available for the next period.
Figure 3.7 The MPS and delivery time.
UNITS
CAPACITY
BOOKED
ORDERS
AVAILABLE
TO PROMISE
TIME
62
Chapter 3
Inventory on hand: 100 units
Period
1
2
3
Customer Orders
80
10
10
MPS
ATP
20
4
5
30
100
100
80
70
Figure 3.8 Available-to-promise calculation.
Continuing with the example problem on page 54, Amalgamated Nut Crackers,
Inc., has now received customer orders. Following is the schedule of orders received
and the resulting available-to-promise calculation:
Week
1
2
3
4
5
6
Customer Orders
80
45
40
50
50
5
MPS
100
100
100
ATP
25
10
45
Sometimes, customer orders are greater than the scheduled receipts. In this
case, the previous ATP is reduced by the amount needed. In this example can the master planner accept an order for another 20 for delivery in week 3? Ten of the units are
available from week 3, and 10 can be taken from the ATP in week 1, so the order can be
accepted as shown in the following.
Week
1
2
3
4
5
6
Customer Orders
80
45
60
50
50
5
MPS
100
100
100
ATP
15
0
45
63
Master Scheduling
EXAMPLE PROBLEM
Calculate the available to promise for the following example. Can an order for 30 more
be accepted for delivery in week 5? What will be the ATP if the order is accepted?
Week
1
2
3
4
5
Customer Orders
50
20
30
30
15
MPS
100
100
ATP
30
25
Answer
Week
1
2
3
4
5
Customer Orders
50
20
30
30
45
MPS
100
100
ATP
25
0
Projected Available Balance
Our calculations so far have based the projected available balance on the forecast
demand. Now there are also customer orders to consider. Customer orders will sometimes be greater than forecast and sometimes less. Projected available balance is now
calculated based on whichever is the greater. For example, if the beginning projected
available balance is 100 units, the forecast is 40 units, and customer orders are
50 units, the ending projected available balance is 50 units, not 60. The projected available balance (PAB) is calculated in one of two ways, depending on whether the period
is before or after the demand time fence. The demand time fence is the number of
periods, beginning with period 1, in which changes are not excepted due to excessive
cost caused by schedule disruption.
For periods before the demand time fence it is calculated as:
PAB = prior period PAB or on-hand balance + MPS - customer orders
This process ignores the forecast and assumes the only effect will be from the
customer orders. Any new orders will have to be approved by senior management.
64
Chapter 3
For periods after the demand time fence, forecast will influence the PAB so it is calculated using the greater of the forecast or customer orders. Thus the PAB becomes:
PAB = prior period PAB + MPS - greater of customer orders or forecast
EXAMPLE PROBLEM
Given the following data, calculate the projected available balance. The demand time
fence is the end of week 3, the order quantity is 100, 40 are available at the beginning
of the period.
Week
1
2
3
4
5
Forecast
40
40
40
40
40
Customer Orders
39
42
39
33
23
Answer
Week
Projected Available Balance
40
1
2
3
4
5
1
59
20
80
40
MPS
100
100
So far we have considered how to calculate projected available balance and available to promise. Using the Amalgamated Nut Cracker, Inc., example, we now combine
the two calculations into one record. The demand time fence is at the end of 3 weeks.
Week
1
2
3
4
5
6
Forecast Demand
75
50
30
40
70
20
Customer Orders
80
45
40
50
50
5
70
25
85
35
65
45
Projected Available Balance
50
ATP
25
10
45
MPS
100
100
100
65
Master Scheduling
Figure 3.9 Product structure.
B
(LT=6)
A
(LT=2)
C
(LT=5)
D
(LT=8)
E
(LT=16)
Time Fences
Consider the product structure shown in Figure 3.9. Item A is a master-scheduled
item and is assembled from B, C, and D. Item D, in turn, is made from raw material
E. The lead times to make or to buy the parts are shown in parentheses. The lead
time to assemble A is two weeks. To purchase B and C, the respective lead times
are 6 and 5 weeks. To make D takes 8 weeks, and the purchase lead time for raw
material E is 16 weeks. The longest cumulative lead time is thus 26 weeks
1A + D + E = 2 + 8 + 16 = 26 weeks2.
Since the cumulative lead time is 26 weeks, the MPS must have a planning horizon of at least 26 weeks.
Suppose that E is a long-lead-time electronic component and is used in the
assembly of other boards as well as D. When E is received 16 weeks after ordering, a
decision must be made to commit E to be made into a D or to use it in another board.
In 8 weeks, a decision must be made to commit D to the final assembly of A. The
company would not have to commit the E to making D until 10 weeks before delivery
of the A. At each of these stages, the company commits itself to more cost and fewer
alternatives. Therefore, the cost of making a change increases and the company’s
flexibility decreases as production gets closer to the delivery time.
Changes to the master production schedule will occur. For example:
•
•
•
•
Customers cancel or change orders.
Machines break down or new machines are added, changing capacity.
Suppliers have problems and miss delivery dates.
Processes create more scrap than expected.
A company wants to minimize the cost of manufacture and also be flexible
enough to adapt to changing needs. Changes to production schedules can result in
the following:
• Cost increases due to rerouting, rescheduling, extra setups, expediting, and
buildup of work-in-process inventory.
• Decreased customer service. A change in quantity of delivery can disrupt the
schedule of other orders.
• Loss of credibility for the MPS and the planning process.
66
Chapter 3
0
FROZEN
Due
Date
SLUSHY
Demand
Time Fence
LIQUID
Planning
Time Fence
Figure 3.10 MPS and time fences.
Changes that are far off on the planning horizon can be made with little or no
cost or disruption to manufacturing, but the nearer to delivery date, the more disruptive and costly changes will be. To help in the decision-making process, companies
establish zones divided by time fences. Figure 3.10 shows how this concept might be
applied to product A. The zones and time fences are as follows:
• Frozen zone. Capacity and materials are committed to specific orders. Since
changes would result in excessive costs, reduced manufacturing efficiency, and
poor customer service, senior management’s approval is usually required to
make changes. The extent of the frozen zone is defined by the demand time
fence. Within the demand time fence, demand is usually based on customer
orders, not forecast.
• Slushy zone. Capacity and material are committed to less extent. This is an area
for trade-offs that must be negotiated between marketing and manufacturing.
Materials have been ordered and capacity established; these are difficult to
change. However, changes in priorities are easier to change. The extent of the
slushy zone is defined by the planning time fence. Within this time fence the
computer will not reschedule MPS orders.
• Liquid zone. Any change can be made to the MPS as long as it is within the limits set by the production plan. Changes are routine and are often made by the
computer program.
Changes to the MPS will occur. They must be managed and decisions made
with full knowledge of the costs involved.
Error Management
Errors in customer orders occur all the time and require constant attention. Three
general types of errors occur:
1. Wrong product or specification.
2. Wrong amount (too little or too much).
3. Wrong shipping date (too early or too late).
They require different responses, reengineering, or alteration, negotiation of
partial shipment, or expediting of shipment.
67
Master Scheduling
SUMMARY
The master production schedule (MPS) is a plan for the production of individual end
items. It must match demand for the product in total, but it is not a forecast of
demand. The MPS must be realistic. It must be achievable and reflect a balance
between required and available capacity.
The MPS is the meeting ground for sales and production. It provides a
plan from which realistic delivery promises can be made to customers. If adjustments have to be made in deliveries or the booking of orders, they are done
through the MPS.
Master production scheduling’s major functions are as follows:
• To form the link between production planning and what manufacturing
builds.
• To plan capacity requirements. The master production schedule determines the
capacity required.
• To plan material requirements. The MPS drives the material requirements plan.
• To keep priorities valid. The MPS is a priority plan for manufacturing.
• To aid in making order promises. The MPS is a plan for what is to be produced
and when. As such, it tells sales and manufacturing when goods will be available
for delivery.
• To be a contract between marketing and manufacturing. It is an agreed-upon
plan.
The MPS must be realistic and based on what production can and will do. If it is
not, the results will be as follows:
• Overload or underload of plant resources.
•
•
•
•
Unreliable schedules resulting in poor delivery performance.
High levels of work-in-process (WIP) inventory.
Poor customer service.
Loss of credibility in the planning system.
KEY TERMS
Master production
schedule 49
Available to promise 61
Scheduled receipt 61
Projected available balance
(PAB) 63
Demand time fence 63
Frozen zone 66
Slushy zone 66
Planning time fence 66
Liquid zone 66
68
Chapter 3
QUESTIONS
1. What four functions does the master production schedule (MPS) perform in the production planning system?
2. What functions does the MPS perform between sales and production?
3. Does the MPS work with families of products or with individual items?
4. Where does the information come from to develop an MPS?
5. What are the three steps in making an MPS?
6. What is the purpose of a rough-cut capacity plan?
7. Where is the resource bill used?
8. At what level should master production scheduling take place?
a. In a make-to-stock environment?
b. In a make-to-order environment?
c. In an assemble-to-order environment?
9. What is a final assembly schedule (FAS)? What is its purpose?
10. What is a planning horizon? What decides its minimum time? Why would it be longer?
11. How do the production plan and the MPS relate to sales and to the sales forecast?
12. What is the ATP (available to promise)? How is it calculated?
13. What is the purpose of time fences? Name and describe the three main divisions.
14. What would happen if the planning horizon for the master schedule were too short? Why?
15. What potential problem might arise if time fences are not used? Why?
16. What types of production environments might use both the FAS and the MPS? Why?
PROBLEMS
3.1
The Wicked Witch Whisk Company manufactures a line of broomsticks. The most popular is the 36-inch model, and the sales department has prepared a forecast for 6 weeks.
The opening inventory is 30. As master scheduler, you must prepare an MPS. The
brooms are manufactured in lots of 100.
Week
1
2
3
4
5
6
Forecast Sales
10
50
25
50
10
15
Projected Available Balance
30
MPS
Answer.
There should be scheduled receipts in weeks 2 and 4.
69
Master Scheduling
3.2
The Shades Sunglass Company assembles sunglasses from frames, which it makes, and
lenses, which it purchases from an outside supplier. The sales department has prepared
the following 6-week forecast for Ebony, a popular model. The sunglasses are assembled
in lots of 200, and the opening inventory is 300 pairs. Complete the projected available
balance and the master production schedule.
Week
Forecast Sales
Projected Available Balance
1
2
3
4
5
6
200
300
350
200
150
150
300
MPS
3.3
Amalgamated Mailbox Company manufactures a family of two mailboxes. The production plan and the MPS are developed on a quarterly basis. The forecast for the product
group follows. The opening inventory is 270 units, and the company wants to reduce this
to 150 units at the end of the year. Develop a level production plan.
Production Plan
Quarter
Forecast Sales
Projected Available Balance
1
2
3
4
220
300
200
200
Total
270
Production Plan
Answer.
Quarterly production = 200 units
The forecast sales for each of the mailboxes in the family also follow. Develop an MPS
for each item, bearing in mind that production is to be leveled as in the production plan.
For each mailbox, the lot size is 200.
Mailbox A.
Lot size: 200
Quarter
Forecast Sales
Projected Available Balance
1
2
3
4
120
180
100
120
120
MPS
Answer.
Scheduled receipts in quarters 2 and 3
Total
70
Chapter 3
Mailbox B.
Lot size: 200
Quarter
Forecast Sales
Projected Available Balance
1
2
3
4
100
120
100
80
Total
150
MPS
Answer.
3.4
Scheduled receipts in quarters 1 and 4
Worldwide Can-Openers, Inc., makes a family of two hand-operated can openers. The
production plan is based on months. There are 4 weeks in this month. Opening inventory
is 2000 dozen, and it is planned to increase that to 4000 dozen by the end of the month.
The MPS is made using weekly periods. The forecast and projected available balance for
the two models follow. The lot size for both models is 1000 dozen. Calculate the production plan and the MPS for each item.
Production Plan
Week
Forecast
Projected Available Balance
1
2
3
4
3000
3500
3500
4000
1
2
3
4
2000
2000
2500
2000
Total
2000
Production Plan
Model A
Week
Forecast
Projected Available Balance
MPS
1500
Total
71
Master Scheduling
Model B
Week
Forecast
Projected Available Balance
1
2
3
4
1000
1500
1000
2000
Total
500
MPS
3.5
In the example given on page 51, the MPS was unsatisfactory because there were poor
inventory balances compared to the production plan. There was also a stockout for
product C in periods 2 and 3. Revise the production plans for the three products to cut
out or reduce these problems.
3.6
The Acme Widget Company makes widgets in two models, and the bottleneck operation
is in work center 10. Following is the resource bill (in hours per part).
Hours per Part
Work Center
Model A
Model B
10
2.5
3.3
The master production schedule for the next 5 weeks is:
Week
1
2
3
4
5
Model A
70
50
50
60
45
Model B
20
40
55
30
45
a. Using the resource bill and the master production schedule, calculate the number of
hours required in work center 10 for each of the 5 weeks. Use the following table to
record the required capacity on the work center.
72
Chapter 3
Week
1
2
3
4
5
Model A
Model B
Total Hours
Answer.
The total hours required are: week 1, 241; week 2, 257; week 3, 307;
week 4, 249; and week 5, 261.
b. If the available capacity at work station 10 is 260 hours per week, suggest possible
ways of meeting the demand in week 3.
3.7 Calculate the available to promise using the following data. There are 100 units on
hand.
Week
1
2
3
4
5
Customer Orders
70
70
20
40
10
MPS
100
100
6
100
ATP
Answer.
3.8
ATP in week 1, 30; week 2, 10; week 4, 50; and week 6, 100.
Given the following data, calculate how many units are available to promise.
Week
1
Customer Orders
MPS
ATP
2
3
4
21
14
9
30
30
30
5
6
3
73
Master Scheduling
3.9
Using the scheduled receipts, calculate the ATP. There are zero units on hand.
Week
1
2
Customer Orders
10
MPS
50
3
4
10
5
6
60
18
7
8
9
10
10
50
50
ATP
3.10 Using the scheduled receipts, calculate the ATP. There are 45 units on hand.
Week
1
2
3
4
5
6
7
8
Customer Orders
45
50
40
40
40
40
30
15
MPS
100
100
100
100
ATP
3.11 Calculate the available to promise using the following data. There are 60 units on hand.
Week
1
2
3
4
5
6
Customer Orders
20
50
30
30
50
30
MPS
100
100
ATP
3.12 Given the following data, can an order for 20 for delivery in week 4 be accepted?
Calculate the ATP using the following table. On hand = 50 units.
Week
1
2
3
4
5
6
7
8
Customer Orders
50
50
30
40
50
40
30
15
MPS
ATP
100
100
100
100
74
Chapter 3
Answer.
Yes. Ten can come from the ATP for week 4 and 10 from the ATP for
week 2.
3.13 Given the following data, can an order for 30 more units for delivery in week 5 be
accepted? If not, what do you suggest can be done?
Week
1
2
3
4
5
6
7
8
Customer Orders
70
10
50
40
10
15
20
15
MPS
100
100
100
ATP
3.14 Given the following data, calculate the projected available balance and the planned MPS
receipts. The lot size is 200. The time fence is 2 weeks.
Week
1
2
3
4
Forecast
80
80
80
70
Customer Orders
100
90
50
40
Projected Available Balance
140
MPS
Answer.
There is a planned MPS receipt in week 2.
3.15 Given the following data, calculate the projected available balance and the planned MPS
receipts. The lot size is 100. The time fence is 2 weeks.
Week
1
2
3
4
Forecast
50
50
50
50
Customer Orders
60
30
60
20
Projected Available Balance
MPS
60
75
Master Scheduling
3.16 Complete the following problem. The lead time is one week and the demand time fence
is week 3. There are 20 on hand. The lot size is 60.
Period
1
2
3
4
5
6
Forecast
20
21
22
20
28
25
Customer Orders
19
18
20
18
30
22
Projected Available Balance
MPS
ATP
20
76
Chapter 3
ACME WATER PUMPS
The Acme Water Pump company has a problem. The pumps are fairly expensive to
make and store, so the company tends to keep the inventory low. At the same time,
it is important to respond to demand quickly, since a customer who wants a water
pump is very likely to get one from a competitor if Acme doesn’t have one available
immediately. Acme’s current policy to produce pumps is to produce 100 per week,
which is the average demand. Even this is a problem, as the production manager has
pointed out, since the equipment is also used for other products and the lot size of
300 would be much more efficient. He said he is currently set up for water pump
production for the next week and states he has capacity available to produce 300 at a
time next week.
The following lists the forecasts and actual customer orders for the next 12 weeks:
Week
Forecast
1
90
2
120
3
110
4
80
5
85
6
95
7
100
8
110
9
90
10
90
11
100
12
110
Customer Orders
105
97
93
72
98
72
53
21
17
6
2
5
The president of Acme has said that he wants to consider using a formal MPS with
ATP logic to try to meet demand more effectively without a large impact on inventory. Acme has decided to use a demand time fence at the end of week 3 and has also
found out that its current inventory is 25 units. Assume Acme will use the MPS lot
size of 300 and that it will produce the first of those lots in week 1.
Discussion Questions
1. Develop a master schedule using the information above.
2. A customer has just requested a major order of 45 pumps for delivery in week 5. What
would you tell the customer about having such an order? Why? What, if anything, would
such an order do to the operation?
4
Material Requirements
Planning
INTRODUCTION
Chapter 3 described the role of the master production schedule (MPS) in showing
the end items, or major components, that manufacturing intends to build. These
items are made or assembled from components that must be available in the right
quantities and at the right time to meet the MPS requirements. If any component is
missing, the product cannot be built and shipped on time. Material requirements
planning (MRP) is the system used to avoid missing parts. It establishes a schedule
(priority plan) showing the components required at each level of the assembly and,
based on lead times, calculates the time when these components will be needed.
This chapter will describe bills of material (the major building block of material
requirements planning), detail the MRP process, and explain how the material
requirements plan is used. But first, some details about the environment in which
MRP operates.
Nature of Demand
There are two types of demand: independent and dependent. Independent demand is
not related to the demand for any other product. For example, if a company makes
wooden tables, the demand for the tables is independent. Master production schedule items are independent demand items.
77
78
Chapter 4
Independent Demand
(Forecast)
Table
Legs
(4)
Ends
(2)
Sides
(2)
Top
(1)
Hardware
Kit
(1)
Dependent Demand
(Calculated)
Figure 4.1 Product tree.
The demand for the sides, ends, legs, and tops depends on the demand for the
tables, and these are dependent demand items.
Figure 4.1 is a product tree that shows the relationship between independent
and dependent demand items. The figures in parentheses show the required quantities of each component.
Since independent demand is not related to the demand for any other assemblies or products, it must be forecast. However, since dependent demand is directly
related to the demand for higher-level assemblies or products, it can be calculated.
Material requirements planning is designed to do this calculation.
An item can have both a dependent and an independent demand. A service or
replacement part has both. The manufacturer of vacuum cleaners uses flexible hose
in the assembly of the units. In the assembly of the vacuums, the hose is a dependent
demand item. However, the hose has a nasty habit of breaking, and the manufacturer
must have replacement hoses available. Demand for replacement hoses is independent since demand for them does not depend directly upon the number of vacuums
manufactured.
Dependency can be horizontal or vertical. The dependency of a component on
its parent is vertical. However, components also depend on each other (horizontal
dependency). If one component is going to be a week late, then the final assembly is
a week late. The other components are not needed until later. This is also a dependency and is called horizontal dependency. Planners are concerned with horizontal
dependency when a part is delayed or there is a shortage, for then other parts will
have to be rescheduled.
Objectives of MRP
Material requirements planning has two major objectives: determine requirements
and keep priorities current.
Determine requirements. The main objective of any manufacturing planning and
control system is to have the right materials in the right quantities available at the right
time to meet the demand for the firm’s products. The material requirements plan’s
objective is to determine what components are needed to meet the master production
Material Requirements Planning
79
schedule and, based on lead time, to calculate the periods when the components must
be available. It must determine the following:
•
•
•
•
What to order.
How much to order.
When to order.
When to schedule delivery.
Keep priorities current. The demand for, and supply of, components changes
daily. Customers enter or change orders. Components get used up, suppliers are late
with delivery, scrap occurs, orders are completed, and machines break down. In this
ever-changing world, a material requirements plan must be able to reorganize priorities to keep plans current. It must be able to add and delete, expedite, delay, and
change orders.
Linkages to Other Manufacturing Planning
and Control (MPC) Functions
The master production schedule drives the material requirements plan. The MRP is
a priority plan for the components needed to make the products in the MPS. The
plan is valid only if capacity is available when needed to make the components, and
the plan must be checked against available capacity. The process of doing so is called
capacity requirements planning and is discussed in the next chapter.
Material requirements planning drives, or is input to, production activity control
(PAC) and purchasing. MRP plans the release and receipt dates for orders. PAC and
purchasing must plan and control the performance of the orders to meet the due dates.
Figure 4.2 shows a diagram of the production planning and control system with
its inputs and outputs.
The Computer
If a company makes a few simple products, it might be possible to perform material
requirements planning manually. However, most companies need to keep track of
thousands of components in a world of changing demand, supply, and capacity.
In the days before computers, it was necessary to maintain extensive manual
systems and to have large inventories and long lead times. These were needed as a
cushion due to the lack of accurate, up-to-date information and the inability to perform the necessary calculations quickly. Somehow, someone in the organization figured out what was required sooner or, very often, later than needed. “Get it early and
get lots of it” was a good rule then.
Computers are incredibly fast, accurate, and ideally suited for the job at hand.
With their ability to store and manipulate data and produce information rapidly,
manufacturing now has a tool to use modern manufacturing planning and control systems properly. There are many application programs available that will perform the
calculations needed in MRP systems. The computer software program that organizes
80
Chapter 4
INPUT
Business Plan
Financial Plan
Marketing Plan
Capacity
Production Plan
Forecasts
Customer Orders
Inventory
Capacity
MPS
Bill of Materials
Inventory
Capacity
OUTPUT
PRODUCTION
PLAN
MASTER
PRODUCTION
SCHEDULE
MATERIAL
REQUIREMENTS
PLAN
PURCHASING
Aggregate Plan
• By-Product Groups
• Inventory Levels
Detailed Plan
• By Week
• By End Item
Time-Phased
Manufacturing and
Purchase Orders
• For Raw Material
• For Components
PRODUCTION
ACTIVITY
CONTROL
Figure 4.2 Manufacturing planning and control system.
and maintains the bills of material structures and their linkages is called a
bill of material processor.
Inputs to the Material Requirements Planning System
There are three inputs to MRP systems:
1. Master production schedule.
2. Inventory records.
3. Bills of material.
Master production schedule. The master production schedule is a statement of
which end items are to be produced, the quantity of each, and the dates they are to be
completed. It drives the MRP system by providing the initial input for the items
needed.
Inventory records. A major input to the MRP system is inventory. When a calculation is made to find out how many are needed, the quantities available must be
considered.
There are two kinds of information needed. The first is called planning factors
and includes information such as order quantities, lead times, safety stock, and scrap.
This information does not change often; however, it is needed to plan what quantities
to order and when to order for timely deliveries.
81
Material Requirements Planning
The second kind of information necessary is on the status of each item. The
MRP system needs to know how much is available, how much is allocated, and how
much is available for future demand. This type of information is dynamic and changes
with every transaction that takes place.
These data are maintained in an inventory record file, also called a part master file
or item master file. Each item has a record, and all the records together form the file.
Bills of material. The bill of material is one of the most important documents in a
manufacturing company. It is discussed next.
BILLS OF MATERIAL
Before we can make something, we must know what components are needed to make
it. To bake a cake, we need a recipe. To mix chemicals together, we need a formula. To
assemble a wheelbarrow, we need a parts list. Even though the names are different,
recipes, formulas, and parts lists tell us what is needed to make the end product. All
of these are bills of material.
The Association for Operations Management (APICS) defines a bill of material as “a listing of all the subassemblies, intermediates, parts, and raw materials that
go into making the parent assembly showing the quantities of each required to make
an assembly.” Figure 4.3 shows a simplified bill of material. There are three important points:
1. The bill of material shows all the parts required to make one of the item.
2. Each part or item has only one part number. A specific number is unique to one
part and is not assigned to any other part. Thus, if a particular number appears
on two different bills of material, the part so identified is the same.
3. A part is defined by its form, fit, or function. If any of these change, then it is not
the same part and it must have a different part number. For example, a part
when painted becomes a different part and must have a different number. If the
part could be painted in three different colors, then each must be identified
with its unique number.
Figure 4.3 Simplified bill of
material.
Description: TABLE
Part Number: 100
Part
Number
Description
Quantity
Required
203
411
622
023
722
Wooden Leg
Wooden Ends
Wooden Sides
Table Top
Hardware Kit
4
2
2
1
1
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Chapter 4
The bill of material shows the components that go into making the parent. It
does not show the steps or process used to make the parent or the components. That
information is recorded in a routing file. This file is discussed in Chapters 5 and 6.
Bills of Material Structure
Bills of material structure refers to the overall design for the arrangement of bills of
material files. Different departments in a company use bills of material for a variety
of purposes. Although each user has individual preferences for the way the bill should
be structured, there must be only one structure, and it should be designed to satisfy
most needs. However, there can be several formats, or ways, to present the bill.
Following are some important formats for bills.
Product tree. Figure 4.4 shows a product tree for the bill of material shown in
Figure 4.3. The product tree is a convenient way to think about bills of material, but it
is seldom used except for teaching and testing. In this text, it is used for that purpose.
Parent–component relationship. The product tree and the bill of material shown
in Figures 4.1 and 4.3 are called single-level structures. An assembly is considered a
parent, and the items that comprise it are called its component items. Figure 4.4 shows
the parent–component relationship of the table (P/N 100). Unique part numbers have
also been assigned to each part. This makes identification of the part absolute.
Multilevel bill. Figure 4.5 shows the same product as the single-level bill shown in
Figures 4.3 and 4.4. However, the single-level components have been expanded into
their components.
Multilevel bills are formed as logical groupings of parts into subassemblies
based on the way the product is assembled. For example, a frame, chassis, doors, windows, and engine are required to construct an automobile. Each of these forms a logical group of components and parts and, in turn, has its own bill of material.
It is the responsibility of manufacturing engineering to decide how the product
is to be made: the operations to be performed, their sequence, and their grouping.
The subassemblies created are the result of this. Manufacturing has decided to
assemble the sides, ends, and leg supports (part of the hardware kit) of the table
(P/N 100) in Figure 4.4 into a frame (P/N 300). The legs, leg bolts, and frame
Table
100
Legs (4)
203
Ends (2)
411
Sides
(2)
622
Figure 4.4 Product tree.
PARENT
Top (1)
023
Hardware
Kit (1)
722
COMPONENT
83
Material Requirements Planning
Table
100
Base
200
Legs (4)
203
Top
023
Leg Bolts (4)
220
Sides (2)
622
Frame (1)
300
Ends (2)
411
Boards (3)
030
Leg
Supports (4)
533
Glue
066
Glue
066
Figure 4.5 Multilevel bill.
subassembly are to be assembled into the base (P/N 200). The top (P/N 023) is to be made
from three boards glued together. Note that the original parts are all there, but they
have been grouped into subassemblies and each subassembly has its own part number.
One convention used with multilevel bills of material is that the last items on
the tree (legs, leg bolts, ends, sides, glue, and boards) are all purchased items.
Generally, a bill of material is not complete until all branches of the product structure
tree end in a purchased part.
Each level in the bill of material is assigned a number starting from the top and
working down. The top level, or end product level, is level zero, and its components
are at level one.
Multiple bill. A multiple bill is used when companies usually make more than one
product, and the same components are often used in several products. This is particularly true with families of products. Using our example of a table, this company
makes two models. They are similar except the tops are different. Figure 4.6 shows
the two bills of material. Because the boards used in the top are different, each top
has a different part number. The balance of the components are common to both
tables.
Single-level bill. A single-level bill of material contains only the parent and its
immediate components, which is why it is called a single-level bill. The tables shown
in Figure 4.6 have six single-level bills, and these are shown in Figure 4.7. Note that
many components are common to both tables.
The computer stores information describing the product structure as a singlelevel bill. A series of single-level bills is needed to completely define a product. For
example, the table needs four single-level bills, one each for the table, base, top, and
frame. These can be chained together to form a multilevel, or indented, bill. Using
84
Chapter 4
Table
100
Base
200
Legs (4)
203
Top
023
Leg Bolts (4)
220
Sides (2)
622
Frame (1)
300
Ends (2)
411
Boards (3)
030
Leg
Supports (4)
533
Glue
066
Glue
066
Table
150
Base
200
Legs (4)
203
Top
025
Leg Bolts (4)
220
Sides (2)
622
Frame (1)
300
Ends (2)
411
Boards (3)
035
Leg
Supports (4)
533
Glue
066
Glue
066
Figure 4.6 Multiple bills.
this method, the information has to be stored only once. For example, the frame
(P/N 300) might be used on other tables with different legs or tops.
There are several advantages to using single-level bills including the following:
• Duplication of records is avoided. For instance, base 200 is used in both table
100 and table 150. Rather than have two records of base 200—one in the bill for
table 100 and one in the bill for table 150—only one record need be kept.
• The number of records and, in computer systems, the file size are reduced by
avoiding duplication of records.
• Maintaining bills of material is simplified. For example, if there is a change in
base 200, the change need be made in only one place.
85
Material Requirements Planning
Table
100
Table
150
Base
200
Top
023
Base
200
Legs (4)
203
Base
200
Top
025
Top
023
Leg Bolts (4)
220
Frame (1)
300
Boards (3)
030
Top
025
Glue
066
Boards (3)
035
Glue
066
Frame (1)
300
Sides (2)
622
Leg
Supports (4)
533
Ends (2)
411
Glue
066
Figure 4.7 Single-level bills.
EXAMPLE PROBLEM
Using the following product tree, construct the appropriate single-level trees. How
many Ks are needed to make 100 Xs and 50 Ys?
X
B(2)
F
C
G(2)
J
Y
D
M(2)
K(2)
L
N
P
M
N(2)
G
J
K(2)
O
86
Chapter 4
Answer
Y
X
B(2)
C
B
F
G(2)
M(2)
D
L
D
L
N
P
M
N(2)
O
G
G
J
K(2)
Each X requires two Bs
Each B requires two Gs 2 * 2
100 Xs require
Each Y requires one L
Each L requires one G 1 * 1
50 Ys require
Total Gs required
Each G requires two Ks
Total Ks required 2 * 450
= 4 Gs
= 400 Gs
=
1G
50 Gs
= 450
= 900
Indented bill. A multilevel bill of material can also be shown as an indented bill of
material. This bill uses indentations as a way of identifying parents from components.
Figure 4.8 shows an indented bill for the table in Figure 4.5.
The components of the parent table are listed flush left, and their components are
indented. The components of the base (legs, leg bolts, and frame) are indented immediately below their parents. The components of the frame are further indented immediately below their parents. Thus, the components of the frame are further indented
immediately below their parents. Thus, the components are linked to their parents by
indenting them as subentries and by listing them immediately below the parents.
Summarized parts list. The bill of material shown in Figure 4.3 is called a
summarized parts list. It lists all the parts needed to make one complete assembly.
The parts list is produced by the product design engineer and does not contain any
information about the way the product is made or assembled.
87
Material Requirements Planning
Figure 4.8 Indented bill of
material.
MANUFACTURING BILL OF MATERIAL
TABLE P/N 100
Part
Number
200
203
220
300
622
411
533
066
023
030
066
Description
Quantity
Required
Base
Legs
Leg Bolts
Frame
Sides
Ends
Leg Supports
Glue
Top
Boards
Glue
1
4
4
1
2
2
4
1
3
Planning bill. A major use of bills of material is to plan production. Planning bills
are an artificial grouping of components for planning purposes. They are used to simplify forecasting, master production scheduling, and material requirements planning.
They do not represent buildable products but an average product. Using the table
example, suppose the company manufactured tables with three different leg styles,
three different sides and ends, and three different tops. In total, they are making
3 * 3 * 3 = 27 different tables, each with its own bill of material. For planning purposes, the 27 bills can be simplified by showing the percentage split for each type of
component on one bill. Figure 4.9 shows how the product structure would look. The
percentage usage of components is obtained from a forecast or past usage. Note the
percentage for each category of component adds up to 100%.
Table
Common
Parts
100%
Legs
Sides
Tops
Leg A
40%
Side A
55%
Top A
45%
Leg B
35%
Side B
30%
Top B
30%
Leg C
25%
Side C
15%
Top C
25%
Figure 4.9 Planning bill.
88
Chapter 4
Where-Used and Pegging Reports
Where-used report. Where-used reports give the same information as a bill of
material, but the where-used report gives the parents for a component whereas the
bill gives the components for a parent. A component may be used in making several
parents. Wheels on an automobile, for example, might be used on several models of
cars. A listing of all the parents in which a component is used is called a where-used
report. This has several uses, such as in implementing an engineering change, or
when materials are scarce, or in costing a product.
Pegging report. A pegging report is similar to a where-used report. However, the
pegging report shows only those parents for which there is an existing requirement,
whereas the where-used report shows all parents for a component. The pegging
report shows the parents creating the demand for the components, the quantities
needed, and when they are needed. Pegging keeps track of the origin of the demand.
Figure 4.10 shows an example of a product tree in which part C is used twice and a
pegging report.
Uses for Bills of Material
The bill of material is one of the most widely used documents in a manufacturing
company. Some major uses are as follows:
• Product definition. The bill specifies the components needed to make the
product.
• Engineering change control. Product design engineers sometimes change the
design of a product and the components used. These changes must be recorded
and controlled. The bill provides the method for doing so.
• Service parts. Replacement parts needed to repair a broken component are
determined from the bill of material.
A
Pegged Requirements
Item
Number
C
B
C
Week
1
2
3
4
5
50
125
25
50
150
25
50
50
Source of Requirements
A
C
D
Figure 4.10 Pegged requirements.
B
50
25
100
100
Material Requirements Planning
89
• Planning. Bills of material define what materials have to be scheduled to make
the end product. They define what components have to be purchased or made
to satisfy the master production schedule.
• Order entry. When a product has a very large number of options (e.g., cars), the
order-entry system very often configures the end product bill of materials. The
bill can also be used to price the product.
• Manufacturing. The bill provides a list of the parts needed to make or assemble
a product.
• Costing. Product cost is usually broken down into direct material, direct labor,
and overhead. The bill provides not only a method of determining direct material but also a structure for recording direct labor and distributing overhead.
This list is not complete, but it shows the extensive use made of the bill of material in manufacturing. There is scarcely a department of the company that will not use
the bill at some time. Maintaining bills of material and their accuracy is extremely
important. Again, the computer is an excellent tool for centrally maintaining bills and
for updating them.
MATERIAL REQUIREMENTS PLANNING PROCESS
Each component shown on the bill of material is planned for by the material requirements planning system. For convenience, it is assumed that each component will go
into inventory and be accounted for. Whether the components actually go into a
physical inventory or not is unimportant. However, it is important to realize that
planning and control take place for each component on the bill. Raw material may go
through several operations before it is processed and ready for assembly, or there
may be several assembly operations between components and parent. These operations are planned and controlled by production activity control, not material requirements planning.
The purpose of material requirements planning is to determine the components
needed, quantities, and due dates so items in the master production schedule are
made on time. This section presents the basic MRP techniques for doing so. These
techniques are discussed under the following headings:
•
•
•
•
•
•
Exploding and Offsetting
Gross and Net Requirements
Releasing Orders
Capacity Requirements Planning
Low-Level Coding and Netting
Multiple Bills of Material
90
Chapter 4
Figure 4.11 Product tree with
lead time.
A
B
D
LT: 1 week
LT: 1 week
LT: 2 weeks
E
C
LT: 1 week
LT: 1 week
Exploding and Offsetting
Consider the product tree shown in Figure 4.11. It is similar to the ones used before
but contains another necessary piece of information: lead time (LT).
Lead time. Lead time is the span of time needed to perform a process. In manufacturing it includes time for order preparation, queuing, processing, moving, receiving and inspecting, and any expected delays. In Figure 4.11, if B and C are available,
it will take one week to assemble A. Thus, the lead time for A is one week. Similarly,
if D and E are available, the time required to manufacture B is two weeks. The purchase lead times for D, E, and C are all one week.
In this particular product tree, the usage quantities—the quantity of components needed to make one of a parent—are all one. To make an A requires one B and
one C, and to make a B requires one D and one E.
Exploding the requirements. Exploding is the process of multiplying the
requirements by the usage quantity and recording the appropriate requirements
throughout the product tree.
Offsetting. Offsetting is the process of placing the exploded requirements in their
proper periods based on lead time. For example, if 50 units of A are required in week
5, the order to assemble the As must be released in week 4, and 50 Bs and 50 Cs must
be available in week 4.
Planned orders. If it is planned to receive 50 of part A in week 5 and the lead time
to assemble an A is one week, the order will have to be released and production
started no later than week 4.
91
Material Requirements Planning
Thus, there should be a planned order receipt for 50 in week 5 and a planned
order release for that number in week 4. If an order for 50 As is to be released in
week 4, 50 Bs and 50 Cs must be available in that week. Thus, there must be planned
order receipts for those components in week 4. Since the lead time to assemble a B is
two weeks, there must be a planned order release for the Bs in week 2. Since the lead
time to make a C is one week, there must be a planned order release for 50 in week 3.
The planned order receipts and planned order releases for the Ds and Es are determined in the same manner. Figure 4.12 shows when orders must be released and
received so the delivery date can be met.
EXAMPLE PROBLEM
Using the product tree and lead times shown in Figure 4.11, complete the following
table to determine the planned order receipts and releases. There are 50 As required
in week 5 and 100 in week 6.
Answer
Week
Part Number
A
B
C
D
E
1
2
3
Planned Order Receipt
Planned Order Release
Planned Order Receipt
Planned Order Release
50
Planned Order Receipt
Planned Order Release
4
5
6
50
100
100
50
50
100
50
100
100
100
50
Planned Order Receipt
Planned Order Release
50
100
100
50
Planned Order Receipt
Planned Order Release
50
100
100
50
92
Chapter 4
Week
Part Number
A
B
C
D
E
1
2
3
Planned Order Receipt
Planned Order Release
4
5
50
50
Planned Order Receipt
Planned Order Release
50
50
Planned Order Receipt
Planned Order Release
50
50
Planned Order Receipt
Planned Order Release
50
50
Planned Order Receipt
Planned Order Release
50
50
Figure 4.12 Exploding and offsetting.
Gross and Net Requirements
The previous section assumed that no inventory was available for the As or any of the
components. Often inventory is available and must be included when calculating
quantities to be produced. If, for instance, there are 20 As in stock, only 30 need to be
made. The requirements for component parts would be reduced accordingly. The
calculation is as follows:
Gross requirement
Inventory available
Net requirements
Net requirements
=
=
=
=
50
20
gross requirements - available inventory
50 - 20 = 30 units
Since only 30 As need to be made, the gross requirement for Bs and Cs is
only 30.
The planned order release of the parent becomes the
gross requirement of the component.
The time-phased inventory record shown in Figure 4.12 can now be modified to
consider any inventory available. For example, suppose there are 10 Bs available as
93
Material Requirements Planning
Week
Part Number
A
B
C
D
E
Gross Requirements
Projected Available 20
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
1
2
3
4
20
20
20
20
Gross Requirements
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
50
0
30
30
30
10
10
10
30
0
20
20
20
Gross Requirements
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
5
30
0
30
30
0
30
0
20
0
20
20
20
0
20
0
20
20
20
Figure 4.13 Gross and net requirements.
well as the 20 As. The requirements for the components D and E would change.
Figure 4.13 shows the change in the MRP record.
EXAMPLE PROBLEM
Complete the following table. Lead time for the part is two weeks. The order quantity
(lot size) is 100 units.
94
Chapter 4
Week
1
2
3
4
50
45
20
1
2
3
4
75
50
25
45
80
20
100
20
60
Gross Requirements
Projected Available
75
Net Requirements
Planned Order Receipt
Planned Order Release
Answer
Week
Gross Requirements
Projected Available
75
Net Requirements
Planned Order Receipt
Planned Order Release
100
Releasing Orders
So far we have looked at the process of planning when orders should be released so
work is done in time to meet gross requirements. In many cases, requirements change
daily. A computer-based material requirements planning system automatically recalculates the requirements for subassemblies and components and re-creates planned
order releases to meet the shifts in demand.
Planned order releases are just planned; they have not been released. It is the
responsibility of the material planner to release planned orders, not the computer.
Since the objective of the MRP is to have material available when it is needed
and not before, orders for material should not be released until the planned order
release date arrives. Thus, an order is not normally released until the planned order is
in the current week (week 1).
Releasing an order means that authorization is given to purchasing to buy the
necessary material or to manufacturing to make the component.
Before a manufacturing order is released, component availability must be
checked. The computer program checks the component inventory records to be sure
that enough material is available and, if so, to allocate the necessary quantity to that
work order. If the material is not available, the computer program will advise the
planner of the shortage.
95
Material Requirements Planning
When the authorization to purchase or manufacture is released, the planned
order receipt is canceled, and a scheduled receipt is created in its place. For the
example shown in Figure 4.13, parts D and E have planned order releases of 20
scheduled for week 1. These orders will be released by the planner, and then the
MRP records for parts D and E will appear as shown in Figure 4.14. Notice that
scheduled receipts have been created, replacing the planned order releases.
When a manufacturing order is released the computer will allocate the required
quantities of a parent’s components to that order. This does not mean the components are withdrawn from inventory but that the projected available quantity is
reduced. The allocated quantity of components is still in inventory, but they are not
available for other orders. They will stay in inventory until withdrawn for use.
Scheduled receipts. Scheduled receipts are orders placed on manufacturing or
on a vendor and represent a commitment to make or buy. For an order in a factory,
necessary materials are committed, and work-center capacity is allocated to that
order. For purchased parts, similar commitments are made to the vendor. The scheduled receipts row shows the quantities ordered and when they are expected to be
completed and available.
Open orders. Scheduled receipts on the MRP record are open orders on the factory
or a vendor and are the responsibility of purchasing and of production activity control.
When the goods are received into inventory and available for use, the order is closed
out, and the scheduled receipt disappears to become part of the on-hand inventory.
Week
Part Number
D
E
1
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Figure 4.14 Scheduled receipts.
0
0
2
20
20
0
0
20
20
0
0
3
4
5
96
Chapter 4
Net requirements. The calculation for net requirements can now be modified to
include scheduled receipts.
Net requirements = gross requirements - scheduled receipts - available inventory
EXAMPLE PROBLEM
Complete the following table. Lead time for the item is two weeks, and the order
quantity is 200. What action should be taken?
Week
1
2
3
4
Gross Requirements
Scheduled Receipts
Projected Available 150
Net Requirements
Planned Order Receipt
Planned Order Release
50
250
200
100
50
Week
1
2
3
4
Gross Requirements
Scheduled Receipts
Projected Available 150
Net Requirements
Planned Order Receipt
Planned Order Release
50
250
200
50
100
50
150
50
200
100
Answer
100
200
The order for 200 units should be released.
Basic MRP Record
Figure 4.15 shows a basic MRP record. There are several points that are important:
1. The current time is the beginning of the first period.
2. The top row shows periods, called time buckets. These are often a week but can
be any length of time convenient to the company. Some companies are moving
to daily time buckets.
97
Material Requirements Planning
Week
Part Number
1
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
2
3
4
10
20
30
5
35
10
10
5
5
5
Figure 4.15 Basic MRP record.
3. The number of periods in the record is called the planning horizon, which shows
the number of future periods for which plans are being made. It should be at
least as long as the cumulative product lead time. Otherwise, the MRP system is
not able to release planned orders of items at the lower level at the correct time.
4. An item is considered available at the beginning of the time bucket in which it is
required.
5. The quantity shown in the projected on-hand row is the projected on-hand balance at the end of the period.
6. The immediate or most current period is called the action bucket. A quantity
in the action bucket means that some action is needed now to avoid a future
problem.
Capacity Requirements Planning
As occurred in the previous planning levels, the MRP priority plan must be checked
against available capacity. At the MRP planning level, the process is called capacity
requirements planning (CRP). The next chapter examines this problem in some
detail. If the capacity is available, the plan can proceed. If not, either capacity has to
be made available or the priority plans changed.
Low-Level Coding and Netting
A component may reside on more than one level in a bill of material. If this is the
case, it is necessary to make sure that all gross requirements for that component have
been recorded before netting takes place. Consider the product shown in Figure 4.16.
Component C occurs twice in the product tree and at different levels. It would be a
mistake to net the requirements for the Cs before calculating the gross requirements
for those required for parent B.
98
Chapter 4
Level
0
A
B
C
C
1
D
2
Figure 4.16 Multilevel product tree.
The process of collecting the gross requirements and netting can be simplified
by using low-level codes. The low-level code is the lowest level on which a part resides
in all bills of material. Every part has only one low-level code. The low-level codes for
the parts in the product tree shown in Figure 4.16 are:
Part
A
B
C
D
Low-Level Code
0
1
2
2
Low-level codes are determined by starting at the lowest level of a bill of material and, working up, recording the level against the part. If a part occurs on a higher
level, its existence on the lower level has already been recorded.
Once the low-level codes are obtained, the net requirements for each part can
be calculated using the following procedure. For the purpose of this exercise, there is
a gross requirement for part A of 50 in week 5, all lead times are one week, and the
following amounts are in inventory: A, 20 units; B, 10 units; and C, 10 units.
Procedure
1. Starting at level zero of the tree, determine if any of the parts on that level have
a low-level code of zero. If so, those parts occur at no lower level, and all the
gross requirements have been recorded. These parts can, therefore, be netted
and exploded down to the next level, that is, into their components. If the lowlevel code is greater than zero, there are more gross requirements, and the part
is not netted. In this example, A has a low-level code of zero so there is no further requirement for As; it can be netted and exploded into its components.
Figure 4.17 shows the results.
2. The next step is to move down to level 1 on the product tree and to repeat the
routine followed in step 1. Since B has a low-level code of 1, all requirements
99
Material Requirements Planning
Week
LowLevel
Code
0
1
2
Part
Number
A
B
C
1
Gross Requirements
Scheduled Receipts
Projected Available 20
Net Requirements
Planned Order Receipt
Planned Order Release
2
3
4
5
50
20
20
20
20
0
30
30
30
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
30
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
30
Figure 4.17 Netting and exploding zero-level parts.
for B are recorded, and it can be netted and exploded. The bill of material for B shows that it is made from a C and a D. Figure 4.18 shows
the result of netting and exploding the Bs. Part C has a low-level code of 2,
which tells us there are further requirements for Cs and at this stage they are
not netted.
3. Moving down to level 2 on the product tree, we find that part C has a low-level
code of 2. This tells us that all gross requirements for Cs are accounted for and
that we can proceed and determine its net requirements. Notice there is a
requirement for 30 Cs in week 4 to be used on the As and a requirement of 20 Cs
in week 3 to be used on the Bs. Looking at its bill of material, we see that it is a
purchased part and no explosion is needed.
Figure 4.19 shows the completed material requirements plan. The process of
level-by-level netting is now completed using the low-level codes of each part. The
low-level codes are used to determine when a part is eligible for netting and exploding.
100
Chapter 4
Week
LowLevel
Code
1
2
2
Part
Number
B
C
D
1
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
2
3
4
5
30
10
10
10
0
20
20
20
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
20
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
20
30
Figure 4.18 Netting and exploding first-level parts.
In this way, each part is netted and exploded only once. There is no time-consuming
re-netting and re-exploding each time a new requirement is met.
Multiple Bills of Material
Most companies make more than one product and often use the same components
in many of their products. The material requirements planning system gathers
the planned order releases from all the parents and creates a schedule of gross
requirements for the components. Figure 4.20 illustrates what happens. Part F is a
component of both C and B.
The same procedure used for a single bill of material can be used when multiple
products are being manufactured. All bills must be netted and exploded level by level
as was done for a single bill.
Figure 4.21 shows the product trees for two products. Both are made from
several components, but, for simplicity, only those components containing an F
101
Material Requirements Planning
Week
LowLevel
Code
0
1
2
2
Part
Number
A
B
C
D
1
Gross Requirements
Scheduled Receipts
Projected Available 20
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
2
3
4
5
50
20
20
20
20
0
30
30
30
30
10
10
10
0
20
20
20
10
10
10
20
30
0
10
10
30
0
30
30
20
0
0
0
20
20
20
Figure 4.19 Completed material requirements plan.
are shown in the product tree. Note that both have F as a component but at different
levels in their product tree. All lead times are one week. The quantities required are
shown in parentheses; that is, two Cs are required to make an A, one F is required to
make a C, and two Fs are needed to make a B. Figure 4.22 shows the completed
material requirements plan that would result if 50 As were required in week 5 and 30
Bs in week 3.
Scrap is usually stated as a scrap allowance. For example, a process may generate 15% scrap. The net requirement might be for 300 units. With a scrap allowance of
15% the process would be required to make 330 , 11.0 - .152 = 353 units.
102
Chapter 4
B
F
C
(1)
G
(1)
E
Part B
(2)
F
(2)
Part C
Week
1
2
Planned Order
Release
20
20
Week
3
1
Planned Order
Release
2
3
30
30
Part F
Week
1
2
3
Gross
Requirements
20
80
60
Figure 4.20 Multiproduct MRP explosion.
Figure 4.21 Multiproduct
tree.
A
B
C(2)
F(1)
F(2)
USING THE MATERIAL REQUIREMENTS PLAN
The people who manage the material requirements planning system are planners.
They are responsible for making detailed decisions that keep the flow of material
moving into, through, and out of the factory. In many companies where there are
thousands of parts to manage, planners are usually organized into logical groupings
based on the similarity of parts or supply.
The basic responsibilities of a planner are to:
1.
2.
3.
4.
5.
Launch (release) orders to purchasing or manufacturing.
Reschedule due dates of open (existing) orders as required.
Reconcile errors and try to find their cause.
Solve critical material shortages by expediting or replanning.
Coordinate with other planners, master production schedulers, production
activity control, and purchasing to resolve problems.
103
Material Requirements Planning
Week
LowLevel
Code
0
0
1
2
Part
Number
A
B
C
F
1
Gross Requirements
Scheduled Receipts
Projected Available 20
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available 10
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
2
3
4
5
20
20
20
5
0
20
0
30
30
30
30
10
10
0
20
20
20
60
10
10
10
0
50
50
50
40
40
50
0
40
40
50
0
50
50
Figure 4.22 Partial material requirements plan.
The material planner works with three types of orders: planned, released,
and firm.
Planned orders. Planned orders are automatically scheduled and controlled by
the computer. As gross requirements, projected available inventory, and scheduled
receipts change, the computer recalculates the timing and quantities of planned
order releases. The MRP program recommends to the planner the release of an
order when the order enters the action bucket but does not release the order.
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Chapter 4
Released orders. Releasing, or launching, a planned order is the responsibility of
the planner. When released, the order becomes an open order to the factory or to
purchasing and appears on the MRP record as a scheduled receipt. It is then under
the control of the planner, who may expedite, delay, or even cancel the order.
Firm planned orders. The computer-based MRP system automatically recalculates planned orders as the gross requirements change. At times, the planner may
prefer to hold a planned order firm against changes in quantity and time despite what
the computer calculates. This might be necessary because of future availability of
material or capacity or special demands on the system. The planner can tell the computer that the order is not to be changed unless the planner advises the computer to
do so. The order is “firmed” or frozen against the logic of the computer.
The MRP software nets, offsets, and explodes requirements and creates planned
order releases. It keeps priorities current for all planned orders according to changes in
gross requirements for the part. But it does not issue purchase or manufacturing orders
or reschedule open orders. However, it does print action or exception messages,
suggesting that the planner should act and what kind of action might be appropriate.
Exception messages. If the manufacturing process is under control and the material requirements planning system is working properly, the system will work according to plan. However, sometimes there are problems that need the attention of the
planner. A good MRP system generates exception messages to advise the planner
when some event needs attention. Following are some examples of situations that will
generate exception messages.
• Components for which planned orders are in the action bucket and which
should be considered for release.
• Open orders for which the timing or quantity of scheduled receipts does not satisfy the plan. Perhaps a scheduled receipt is timed to arrive too early or late, and
its due date should be revised.
• Situations in which the standard lead times will result in late delivery of a
zero-level part. This situation might call for expediting to reduce the standard
lead times.
Transaction messages. Transaction messages mean that the planner must tell
the MRP software of all actions taken that will influence the MRP records. For example, when the planner releases an order, or a scheduled receipt is received, or when
any change to the data occurs, the MRP program must be told. Otherwise, the
records will be inaccurate, and the plan will become unworkable.
Material requirements planners must manage the parts for which they are
responsible. This means not only releasing orders to purchasing and the factory,
rescheduling due dates of open orders, and reconciling differences and inconsistencies but also finding ways to improve the system and removing the causes of potential
error. If the right components are to be in the right place at the right time, the planner must manage the process.
105
Material Requirements Planning
Managing the Material Requirements Plan
The planner receives feedback from many sources such as:
• Suppliers’ actions through purchasing.
• Changes to open orders in the factory such as early or late completions or differing quantities.
• Management action such as changing the master production schedule.
The planner must evaluate this feedback and take corrective action if necessary.
The planner must consider three important factors in managing the material requirements plan.
Priority. Priority refers to maintaining the correct due dates by constantly evaluating the true due-date need for released orders and, if necessary, expediting or deexpediting.
Consider the following MRP record. The order quantity is 300 units and the
lead time is three weeks.
Week
Gross Requirements
Scheduled Receipts
Projected Available 150
Net Requirements
Planned Order Receipt
Planned Order Release
1
2
3
4
5
100
50
150
200
50
0
100
300
200
50
150
150
300
300
What will happen if the gross requirements in week 2 are changed from 50 units
to 150? The MRP record will look like the following.
Week
Gross Requirements
Scheduled Receipts
Projected Available 150
Net Requirements
Planned Order Receipt
Planned Order Release
1
2
3
4
5
100
150
150
200
50
–100
100
300
100
250
50
300
50
300
Note that there is a shortage of 100 units in week 2 and that the planned order
release originally in week 2 is now in week 1. What can the planner do? One solution
is to expedite the scheduled receipt of 300 units from week 3 to week 2. If this is not
106
Chapter 4
possible, the extra 100 units wanted in week 2 must be rescheduled into week 3. Also,
there is now a planned order release in week 1, and this order should be released.
Bottom-up replanning. Action to correct for changed conditions should occur as
low in the product structure as possible. Suppose the part in the previous example is
a component of another part. The first alternative is to expedite the scheduled receipt
of 300 into week 2. If this can be done, there is no need to make any changes to the
parent. If the 300 units cannot be expedited, the planned order release and net
requirement of the parent must be changed.
Reducing system nervousness. Sometimes requirements change rapidly and by
small amounts, causing the material requirements plan to change back and forth. The
planner must judge whether the changes are important enough to react to and
whether an order should be released. One method of reducing system nervousness is
firm planned orders.
EXAMPLE PROBLEM
As the MRP planner, you arrive at work Monday morning and look at the MRP
record for part 2876 as shown below.
Order quantity = 30 units
Lead time = 2 weeks
Week
1
2
3
4
5
6
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
35
30
15
10
15
30
15
20
5
20
10
30
5
15
15
30
30
30
20
10
30
30
20
The computer draws attention to the need to release the planned order for 30 in
week 1. Either you release this order, or there will be a shortage in week 3. During the
first week, the following transactions take place:
a. Only 25 units of the scheduled receipt are received into inventory. The balance
is scrapped.
b. The gross requirement for week 3 is changed to 10.
c. The gross requirement for week 4 is increased to 50.
d. The requirement for week 7 is 15.
e. An inventory count reveals there are 10 more in inventory than the record
shows.
107
Material Requirements Planning
f. The 35 gross requirement for week 1 is issued from inventory.
g. The planned order release for 30 in week 1 is released and becomes a scheduled
receipt in week 3.
As these transactions occur during the first week, you must enter these changes in the
computer record. At the beginning of the next week, the MRP record appears as follows:
Order quantity = 30 units
Lead time = 2 weeks
Week
2
3
4
5
6
7
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
10
50
15
20
15
10
10
30
30
10
20
30
5
20
10
30
30
30
25
5
30
30
20
The opening on-hand balance for week 2 is 20 (20 25 10 35 20). The
planned order release originally set in week 4 has shifted to week 3. Another planned
order has been created for release in week 5. More importantly, the scheduled receipt
in week 3 will not be needed until week 4. You should reschedule this to week 4.
The planned order in week 2 should be released and become a scheduled receipt in
week 4.
SUMMARY
The job of the MRP is to produce the right components at the right time so that the
MPS can be maintained. The MRP depends on accurate bills of material and on
accurate inventory records. Bills of material can be created in many ways, but one
department (or individual) must be responsible for them. Inventory records are indispensable to the MRP, and the MRP is only as good as the inventory records.
The MRP exploding and offsetting processes outlined in this book are largely
done by the computer. The logic used is repetitive and, while error prone when done
by individuals, can be accomplished well by computer. Good MRP practice is
achieved by planners being able to work with the system.
The MRP process uses the bill of materials that lists components used to make
a product, the lead time to make or obtain those components, and the existing inventory of those components to calculate a series of planned order releases to obtain or
make components to meet future product needs.
108
Chapter 4
KEY TERMS
Bill of material processor
80
Master production schedule
80
Planning factors 80
Inventory record file 81
Product tree 82
Parent 82
Component items 82
Multilevel bills 82
Multiple bill 83
Single-level bill 83
Indented bill 86
Summarized parts list 86
Planning bills 87
Where-used report 88
Pegging report 88
Lead time 90
Exploding 90
Offsetting 90
Planned order receipt 91
Planned order release 91
Releasing an order 94
Open orders 95
Scheduled receipts 95
Allocate 95
Net requirements 96
Time buckets 96
Planning horizon 97
Bottom-up replanning
106
Action bucket 97
Low-level code 98
Planned orders 103
Exception messages 104
Transaction messages 104
Firm planned orders 104
Reducing system
nervousness 106
QUESTIONS
1. What is a material requirements plan?
2. What is the difference between dependent and independent demand?
3. Should an MRP be used with dependent or independent demand items?
4. What are the objectives of the MRP?
5. What is the relationship between the MPS and the MRP?
6. Why is a computer necessary in an MRP system?
7. What are the major inputs to the MRP system?
8. What data are found in a part master file or an item master file?
9. What is a bill of material? What are two important points about bills of material?
10. To what does “bill of material structure” refer? Why is it important?
11. Describe the parent–component relationship.
12. Describe the following types of bills of material:
a. Product tree.
b. Multilevel bill.
c. Single-level bill.
d. Indented bill.
e. Summarized parts list.
f. Planning bill.
13. Why do MRP computer programs store single-level bills?
14. Describe each of the seven uses of a bill of material described in the text.
15. What are where-used and pegging reports? Give some of their uses.
109
Material Requirements Planning
16. Describe the processes of offsetting and exploding.
17. What is a planned order? How is it created?
18. From where does the gross requirement of a component come?
19. Who is responsible for releasing an order? Describe what happens to the inventory
records and to PAC and purchasing.
20. What is a scheduled receipt? From where does it originate?
21. What is an open order? How does it get closed?
22. What is the meaning of the term low-level code? What is the low-level code of an
MPS part?
23. What are the responsibilities of a material requirements planner?
24. Describe the differences among planned orders, released orders, and firm planned
orders. Who controls each?
25. What are exception messages? What is their purpose?
26. What is a transaction message? Why is it important?
27. What are the three important factors in managing the material requirements plan? Why
is each important?
28. Describe the problems that might come from using an incorrect bill of material in MRP.
29. Describe how MRP might be used to plan for a change in design for a product.
PROBLEMS
4.1
Using the following product tree, construct the appropriate single-level trees. How many
Cs are needed to make 50 Xs and 100 Ys?
Y
X
A(2)
C(2)
Answer.
4.2
B
B
E(2)
E(2)
C(2)
D
400 Cs
Given the following parents and components, construct a product tree. Figures in parentheses show the quantities per item. How many Gs are needed to make one A?
Parent
Component
A
B(2)
C(4)
D(4)
B
E(2)
F(1)
C
G(2)
E
G(4)
F(3)
H(2)
110
Chapter 4
4.3
Using the following product tree, determine the planned order receipts and planned
order releases if 200 As are to be produced in week 5. All lead times are one week except
for component E, which has a lead time of two weeks.
A
B
C
D
E
Week
Part A
Lead Time: 1 week
Planned Order Receipt
Planned Order Release
Part B
Lead Time: 1 week
Planned Order Receipt
Planned Order Release
Part C
Lead Time: 1 week
Planned Order Receipt
Planned Order Release
Part D
Lead Time: 1 week
Planned Order Receipt
Planned Order Release
1
2
3
4
5
Part E
Planned Order Receipt
Lead Time: 2 weeks Planned Order Release
4.4
Complete the following table. Lead time for the part is two weeks, and the order quantity is 40. What action should be taken?
Week
1
2
3
4
Gross Requirements1
Projected Available
40
Net Requirements
Planned Order Receipt
Planned Order Release
20
15
10
20
Answer.
An order for 40 should be released in week 1.
111
Material Requirements Planning
4.5
Given the following product tree, explode, offset, and determine the gross and net
requirements. All lead times are one week, and the quantities required are shown in
parentheses. The master production schedule calls for 100 As to be available in week 5.
There are 20 Bs available. All other on-hand balances = 0.
A
B(2)
D(1)
C(1)
E(1)
Week
Part A
Lead Time: 1 week
Part B
Lead Time: 1 week
Part C
Lead Time: 1 week
Part D
Lead Time: 1 week
Part E
Lead Time: 1 week
Part F
Lead Time: 1 week
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
D(2)
1
F(1)
2
3
4
5
112
Chapter 4
Answer.
Planned order releases are:
Part A: 100 in week 4
Part B: 180 in week 3
Part C: 100 in week 3
Part D: 380 in week 2
Part E: 180 in week 2
Part F: 100 in week 2
4.6
Complete the following table. Lead time for the part is two weeks. The lot size is 100.
What is the projected available at the end of week 3? When is it planned to release an
order?
Week
1
2
3
4
Gross Requirements
Scheduled Receipts
Projected Available
40
Net Requirements
Planned Order Receipt
Planned Order Release
20
65
100
35
25
Answer.
Projected available at the end of week 3 is 20.
An order release is planned for the beginning of week 2.
4.7 Complete the following table. Lead time for the part is two weeks. The lot size is 50.
What is the projected available at the end of week 3? When is it planned to release an
order?
Week
1
2
3
4
Gross Requirements
Scheduled Receipts
Projected Available
10
Net Requirements
Planned Order Receipt
Planned Order Release
30
50
25
10
10
113
Material Requirements Planning
4.8
Given the following partial product tree, explode, offset, and determine the gross and
net requirements for components H, I, J, and K. There are other components, but they
are not connected to this problem. The quantities required are shown in parentheses.
The master production schedule calls for production of 50 Hs in week 3 and 80 in week 5.
There is a scheduled receipt of 100 Is in week 2. There are 400 Js and 400 Ks available.
H
I(2)
J(2)
K(3)
Week
Part H
Lead Time: 1 week
Part I
Lead Time: 2 weeks
Part J
Lead Time: 1 week
Part K
Lead Time: 1 week
Answer.
1
2
3
4
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available 400
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available 400
Net Requirements
Planned Order Receipt
Planned Order Release
There is a planned order release for part K of 80 in week 1.
5
114
Chapter 4
4.9
MPS parent X has planned order releases of 30 in weeks 2 and 4. Given the following
product tree, complete the MRP records for parts Y and Z. Quantities required are
shown in brackets.
X
Y(1)
Z(2)
Part Y
Lead Time: 2 weeks
Lot Size: 50
S
T
Week
1
2
3
4
3
4
Gross Requirements
Scheduled Receipts
Projected Available
30
Net Requirements
Planned Order Receipt
Planned Order Release
Part Z
Lead Time: 1 week
Lot Size: 100
Week
1
2
Gross Requirements
Scheduled Receipts
Projected Available
20
Net Requirements
Planned Order Receipt
Planned Order Release
4.10 Given the following product tree, explode, offset, and determine the gross and net
requirements. The quantities required are shown in parentheses. The master production
schedule calls for production of 100 As in week 5. There is a scheduled receipt of 100 Bs
in week 1. There are 200 Fs available. All order quantities are lot-for-lot.
115
Material Requirements Planning
A
B(2)
D(1)
C(1)
E(1)
Week
Part A
Lead Time: 1 week
Part B
Lead Time: 1 week
Part C
Lead Time: 1 week
Part D
Lead Time: 1 week
Part E
Lead Time: 1 week
Part F
Lead Time: 1 week
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
D(2)
1
F(1)
2
3
4
5
116
Chapter 4
4.11 Given the following product tree, complete the MRP records for parts X, Y, and Z. Note
that parts X and Y have specified order quantities.
X
Y(3)
Z(1)
Part X
Lead Time: 1 week
Z(2)
W(1)
Week
1
2
3
4
5
Gross Requirements
Scheduled Receipts
Projected Available
10
Net Requirements
Planned Order Receipt
Planned Order Release
15
20
5
15
10
15
Part Y
Gross Requirements
Scheduled Receipts
Lead Time: 2 weeks Projected Available
30
Net Requirements
Planned Order Receipt
Lot Size: 50
Planned Order Release
Part J
Lead Time: 1 week
Lot Size: lot-for-lot
Part K
Lead Time: 1 week
Lot Size: 400
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
50
90
117
Material Requirements Planning
4.12 Given the following product tree, determine the low-level codes for all the components.
A
F
C
E
D
B
Item
D
E
D
A
B
B
C
D
E
F
Low-Level Code
4.13 Given the following product tree, determine the low-level codes for all the components.
A
B
D
C
G
H
Item
Low-Level Code
C
H
J
A
H
E
G
H
B
C
D
E
F
F
E
J
C
G
H
J
118
Chapter 4
4.14 Given the following product tree, develop a material requirements plan for the components. Quantities per are shown in parentheses. The following worksheet shows the present active orders, the available balances, and the lead times.
A
B
C
F
C(2)
Low-Level Code
C
D(2)
Week
Part A
0
Lead Time: 1 week
Lot-for-lot
Part F
0
Lead Time: 1 week
Lot-for-lot
D
1
E
2
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
3
4
60
5
70
100
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Part B
Gross Requirements
Scheduled Receipts
Lead Time: 2 weeks Projected Available 200
Net Requirements
Lot Size: 300
Planned Order Receipt
Planned Order Release
Part C
Gross Requirements
Scheduled Receipts
Lead Time: 2 weeks Projected Available
Net Requirements
Lot Size: Lot-forPlanned Order Receipt
lot
Planned Order Release
Gross Requirements
Scheduled Receipts
Lead Time: 2 weeks Projected Available
Net Requirements
Lot Size: 300
Planned Order Receipt
Planned Order Release
120
Part D
300
Part E
Gross Requirements
Scheduled Receipts
Lead Time: 3 weeks Projected Available 400
Net Requirements
Lot Size: 500
Planned Order Receipt
Planned Order Release
Answer.
The low-level code for part D is 2. There is a planned order release of
300 for part D in week 1. There are no planned order releases for
part E. There is a planned order release of 100 for Part C in week 1
and 140 in week 2.
119
Material Requirements Planning
4.15 Given the following product tree, explode, offset, and determine the gross and net
requirements. All lead times are one week, and the quantities required are shown in
parentheses. The master production schedule calls for production of 100 As in week 4
and 50 in week 5. There are 300 Bs scheduled to be received in week 1 and 200 Ds in
week 3. There are also 20 As available.
A
B(2)
D(1)
C(1)
E(1)
D(2)
B(1)
D(1)
Low-Level
Code
Week
Part A
Lead Time: 1 week
Lot Size: lot-for-lot
Part B
Lead Time: 1 week
Lot Size: lot-for-lot
Part C
Lead Time: 1 week
Lot Size: lot-for-lot
Part D
Lead Time: 1 week
Lot Size: lot-for-lot
Part E
Lead Time: 1 week
Lot Size: lot-for-lot
Gross Requirements
Scheduled Receipts
Projected Available 20
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
E(1)
1
2
3
4
5
120
Chapter 4
4.16 Given the following product tree, determine the low-level codes and the gross and net quantities for each part. There is a requirement for 100 As in week 4 and 50 Bs in week 5. There
is a scheduled receipt of 100 Cs in week 2. Quantities required of each are also shown.
A
B
C(2)
E(1)
D(1)
F(1)
E(2)
C(1)
E(1)
Low-Level
Code
E(1)
E(1)
Lead Time: 1 week
Lot Size: lot-for-lot
Part B
Lead Time: 1 week
Lot Size: lot-for-lot
Part C
Lead Time: 1 week
Lot Size: lot-for-lot
Part D
Lead Time: 1 week
Lot Size: lot-for-lot
Part E
Lead Time: 1 week
Lot Size: 500
Part F
Lead Time: 1 week
Lot Size: lot-for-lot
F(1)
F(1)
Week
Part A
C(1)
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
1
2
3
4
5
121
Material Requirements Planning
4.17 Complete the following MRP record. The lead time is four weeks, and the lot size is 200.
What will happen if the gross requirements in week 3 are increased to 150 units? As a
planner, what actions can you take?
Initial MRP
Week
1
2
3
4
5
Gross Requirements
Scheduled Receipts
Projected Available 100
Net Requirements
Planned Order Receipt
Planned Order Release
50
125
200
100
60
200
40
1
2
3
4
5
Revised MRP
Week
Gross Requirements
Scheduled Receipts
Projected Available 100
Net Requirements
Planned Order Receipt
Planned Order Release
4.18 It is Monday morning, and you have just arrived at work. Complete the following MRP
record as it would appear Monday morning. Lead time is two weeks, and the lot size is 100.
Initial MRP
Week
Gross Requirements
Scheduled Receipts
Projected Available 50
Net Requirements
Planned Order Receipt
Planned Order Release
1
2
3
4
5
70
100
40
80
50
40
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Chapter 4
During the week, the following events occur. Enter them in the MRP record.
a. The planned order for 100 in week 1 is released.
b. Thirty of the scheduled receipts for week 1 are scrapped.
c. An order for 20 is received for delivery in week 3.
d. An order for 40 is received for delivery in week 6.
e. The gross requirements of 70 in week 1 are issued.
MRP record at the end of week 1
Week
Gross Requirements
Scheduled Receipts
Projected Available
Net Requirements
Planned Order Receipt
Planned Order Release
2
3
4
5
6
123
Material Requirements Planning
APIX POLYBOB COMPANY
Ken Mack, plant manager for the Apix Polybob Company, was having a heated discussion with Jim Gould, the production and inventory control manager. Ken was getting tired of frantic calls from Ellen Uphouse, the marketing manager, concerning
late orders for their Polybob customers and was once again after Jim to solve the
problem. Some of the discussion points follow:
JIM: Look, Ken, I’m not sure what more we can do. I’ve reexamined the EOQ (Economic
Order Quantity lot size) values and all the reorder points for all our inventory for all our
Polybob models, including all component levels and purchased items. I’ve implemented
strict inventory control procedures to ensure our accuracy levels to at least 80%, and I’ve
worked with the production people to make sure we are maximizing both labor
efficiency and utilization of our equipment. The real problem is with those salespeople.
We no sooner have a production run nicely going, and they change the order or add
a new one. If they’d only leave us alone for a while and let us catch up with our current
late order bank, we’d be okay. As it is, everyone is getting tired of order changes,
expediting, and making everything into a crisis. Even our suppliers are losing patience
with us. They tend to disbelieve any order we give them until we call them up for a crisis
shipment.
KEN: I find it hard to believe that you really have the EOQ and reorder point values right. If
they were, we shouldn’t have all these part shortages all the time while our overall inventory is going up in value. I also don’t see any way we can shut off the orders coming in. I
can imagine the explosion from Ellen if I even suggested such a thing. She’ll certainly
remind me that our mission statement clearly points out that our number-one priority is
customer service, and refusing orders and order changes certainly doesn’t fit as good
customer service.
JIM: Then maybe the approach is to deal with Frank Adams (the chief financial officer). He’s
the one who is always screaming that we have too much inventory, too much expediting
cost, too much premium freight costs from suppliers, and poor efficiency. I’ve tried to
have him authorize more overtime to relieve some of the late order conditions, but all
he’ll say is that we must be making the wrong models. He continually points to the fact
that the production hours we are paying for currently are more than enough to make our
orders shipped at standard, and that condition has held for over a year. He just won’t
budge on that point. Maybe you can convince him.
KEN: I’m not sure that’s the answer either. I think he has a point, and he certainly has the numbers to back him up. I’d have a real rough time explaining what we were doing to Ron
Marrison (the CEO). There’s got to be a better answer. I’ve heard about a systems
approach called material requirements planning or something like that. Why don’t you
look into that. Take a representative model and see if that approach could help us deal with
A
B
F
C (2 each)
E (3 each)
F (2 each)
E
D
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Chapter 4
what appears to be an impossible situation. I’m sure something would work. I know other
factories have similar production conditions yet don’t seem to have all our problems.
Following is the information about Polybob model A that Ken suggested as a
representative model to use for the analysis:
Component
B
C
D
E
F
Lot Size
Inventory
80
150
200
400
500
10
40
180
300
50
Lead Time Scheduled Receipts Reorder point
1
1
2
2
2
None
None
None
None
500, week 1
5
15
50
70
80
The following are the master schedule production lots for Model A:
Complete 50 units, week 3
Complete 50 units, week 5
Complete 60 units, week 7
Complete 60 units, week 9
Complete 50 units, week 11
Upon seeing this information, Jim stated, “Look at how regular our production
schedule is for this model. The reorder points will more than cover requirements, and
none have lead times that make it tough to respond. This analysis should show that all
the work I did on EOQ and reorder points was right, and the real problem lies with
those sales and finance people who don’t understand our production needs.”
Discussion Questions
1. What are the key issues brought about in the conversation? What are the key symptoms,
and what are the underlying problems? Be specific in your answers.
2. Use the product information to develop an MRP approach to the problems. Would
MRP solve the problems? If so, show specifically how MRP would avoid the problems
discussed by Ken and Jim.
3. Do any conditions bother you about the ability of MRP to deal with the problems? What
specifically are those conditions?
4. Suppose it was discovered that only 250 of component E were in stock instead of the 300
listed on the inventory record. What problems would this cause (if any), and what are
some of the ways that these problems could be addressed? How would (if at all) MRP
help you when other methods might not?
5. Suppose that the design engineer advises that he has a new design for component F. It won’t
be ready until sometime after week 2, but he wants you to give a date for the first supplier
shipment to come in, and you should be ready to tell the supplier how many to ship. Since
the change is transparent to the customer, the design engineer advises you to go ahead and
use up any existing material of the model. How will MRP help you to deal with this issue?
6. Can you think of any other “what if” questions that might be more easily addressed by a
systematic approach such as MRP?
5
Capacity Management
INTRODUCTION
So far we have been concerned with planning priority, that is, determining what
is to be produced and when. The system is hierarchical, moving from long planning
horizons and few details (production plan) through medium time spans (master
production schedule) to a high level of detail and short time spans (material requirements plan). At each level, manufacturing develops priority plans to satisfy
demand. However, without the resources to achieve the priority plan, the plan will
be unworkable. Capacity management is concerned with supplying the necessary
resources. This chapter looks more closely at the question of capacity: what it is,
how much is available, how much is required, and how to balance priority and
capacity.
DEFINITION OF CAPACITY
Capacity is the amount of work that can be done in a specified time period. In the
eleventh edition of the APICS Dictionary, capacity is defined as “the capability of a
worker, machine, work center, plant, or organization to produce output per time
period.” Capacity is a rate of doing work, not the quantity of work done.
125
126
Chapter 5
Two kinds of capacity are important: capacity available and capacity required.
Capacity available is the capacity of a system or resource to produce a quantity of
output in a given time period.
Capacity required is the capacity of a system or resource needed to produce a
desired output in a given time period. A term closely related to capacity required is
load. This is the amount of released and planned work assigned to a facility for a particular time period. It is the sum of all the required capacities.
These three terms—capacity required, load, and capacity available—are important in capacity management and will be discussed in subsequent sections of this
chapter. Capacity is often pictured as a funnel as shown in Figure 5.1. Capacity available is the rate at which work can be withdrawn from the system. Load is the amount
of work in the system.
Capacity management is responsible for determining the capacity needed to
achieve the priority plans as well as providing, monitoring, and controlling that capacity so the priority plan can be met. The eleventh edition of the APICS Dictionary
defines capacity management as “the function of establishing, measuring, monitoring,
and adjusting limits or levels of capacity in order to execute all manufacturing schedules.” As with all management processes, it consists of planning and control functions.
Capacity planning is the process of determining the resources required to meet
the priority plan and the methods needed to make that capacity available. It takes
place at each level of the priority planning process. Production planning, master production scheduling, and material requirements planning determine priorities: what is
wanted and when. These priority plans cannot be implemented, however, unless the
firm has sufficient capacity to fulfill the demand. Capacity planning, thus, links the
various production priority schedules to manufacturing resources.
Capacity control is the process of monitoring production output, comparing it
with capacity plans, and taking corrective action when needed. Capacity control will
be examined in Chapter 6.
Figure 5.1 Capacity
versus load.
LOAD
CAPACITY
AVAILABLE
OUTPUT
Capacity Management
127
CAPACITY PLANNING
Capacity planning involves calculating the capacity needed to achieve the priority
plan and finding ways of making that capacity available. If the capacity requirement
cannot be met, the priority plans have to be changed.
Priority plans are usually stated in units of product or some standard unit of
output. Capacity can sometimes be stated in the same units, for example, tons of steel
or yards of cloth. If there is no common unit, capacity must be stated as the hours
available. The priority plan must then be translated into hours of work required and
compared to the hours available. The process of capacity planning is as follows:
1. Determine the capacity available at each work center in each time period.
2. Determine the load at each work center in each time period.
• Translate the priority plan into the hours of work required at each work center in each time period.
• Sum up the capacities required for each item on each work center to determine the load on each work center in each time period.
3. Resolve differences between available capacity and required capacity. If possible, adjust available capacity to match the load. Otherwise, the priority plans
must be changed to match the available capacity.
This process occurs at each level in the priority planning process, varying only in
the level of detail and time spans involved.
Planning Levels
Resource planning involves long-range capacity resource requirements and is directly
linked to production planning. Typically, it involves translating monthly, quarterly, or
annual product priorities from the production plan into some total measure of capacity, such as gross labor hours. Resource planning involves changes in staffing, capital
equipment, product design, or other facilities that take a long time to acquire and
eliminate. If a resource plan cannot be devised to meet the production plan, the production plan has to be changed. The two plans set the limits and levels for production.
If they are realistic, the master production schedule should work. (See Chapter 2,
Resource Planning.)
Rough-cut capacity planning takes capacity planning to the next level of detail.
The master production schedule is the primary information source. The purpose of
rough-cut capacity planning is to check the feasibility of the MPS, provide warnings
of any bottlenecks, ensure utilization of work centers, and advise vendors of capacity
requirements. (See Chapter 3, Rough-Cut Capacity Planning.)
Capacity requirements planning is directly linked to the material requirements
plan. Since this type of planning focuses on component parts, greater detail is
involved than in rough-cut capacity planning. It is concerned with individual orders at
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Chapter 5
Priority
Capacity
PRODUCTION
PLAN
RESOURCE
PLAN
Long Range
PLAN
MASTER
PRODUCTION
SCHEDULE
ROUGH-CUT
CAPACITY
PLAN
Medium Range
MATERIAL
REQUIREMENTS
PLAN
CAPACITY
REQUIREMENTS
PLAN
Short Range
IMPLEMENT/
CONTROL
PRODUCTION
ACTIVITY
CONTROL
CAPACITY
CONTROL
Short Range
Figure 5.2 Planning levels.
individual work centers and calculates work center loads and labor requirements for
each time period at each work center.
Figure 5.2 shows the relationship between the different levels of priority planning and capacity planning. Notice that, although the upper levels of priority
planning are input to lower levels, the various capacity plans relate only to their level
in the priority plan, not to subsequent capacity planning levels. Resource planning
relates to production planning but is not an input to rough-cut capacity planning.
After the plans are completed, production activity control and purchasing must be
authorized to process, or implement, shop orders and purchase orders. Capacity must
still be considered. Work center capacity control will be covered in the next chapter.
CAPACITY REQUIREMENTS PLANNING (CRP)
The capacity requirements plan (CRP) occurs at the level of the material requirements plan. It is the process of determining in detail the amount of labor and
machine resources needed to achieve the required production. Planned orders from
the MRP and open shop orders (scheduled receipts) are converted into demand for
time in each work center in each time period. This process takes into consideration
the lead times for operations and offsets the operations at work centers accordingly.
In considering open shop orders, it accounts for work already done on a shop order.
Capacity Management
129
Capacity planning is the most detailed, complete, and accurate of the capacity planning techniques. This accuracy is most important in the immediate time periods.
Because of the detail, a great amount of data and computation are required.
Inputs
The inputs needed for a CRP are open shop orders, planned order releases, routings,
time standards, lead times, and work center capacities. This information can be
obtained from the following:
•
•
•
•
Open order file.
Material requirements plan.
Routing file.
Work center file.
Open order file. An open shop order appears as a scheduled receipt on the material requirements plan. It is a released order for a quantity of a part to be manufactured and completed on a specific date. It shows all relevant information such as
quantities, due dates, and operations. The open order file is a record of all the active
shop orders. It can be maintained manually or as a computer file.
Planned order releases. Planned orders are determined by the computer’s MRP
logic based upon the gross requirements for a particular part. They are inputs to the
CRP process in assessing the total capacity required in future time periods.
Routing file. A routing is the path that work follows from work center to work center as it is completed. Routing is specified on a route sheet or, in a computer-based
system, in a route file. A routing file should exist for every component manufactured
and contain the following information:
•
•
•
•
•
•
Operations to be performed.
Sequence of operations.
Work centers to be used.
Possible alternate work centers.
Tooling needed at each operation.
Standard times: setup times and run times per piece.
Figure 5.3 shows an example of a routing file.
Work center file. Work center is composed of a number of machines or workers
capable of doing the same work. The machinery will normally be similar so there are
no differences in the kind of work the machines can do or the capacity of each.
Several sewing machines of similar capacity could be considered a work center.
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Chapter 5
Part Name: Gear shaft
Drawing Number: D123X
Part Number: SG 123
Operation
No.
Work
Center
S/U Time
(standard hours)
Run Time/piece
(standard hours)
10
20
30
40
50
12
14
17
03
Stores
1.50
0.50
0.30
0.45
0.20
0.25
0.05
0.10
Operation
Turn shaft
Mill slot
Drill 2 holes
Grind
Inventory
Figure 5.3 Routing file.
A work center file contains information on the capacity and move, wait, and queue
times associated with the center.
The move time is the time normally taken to move material from one workstation to another. The wait time is the time a job is at a work center after completion and
before being moved. The queue time is the time a job waits at a work center before
being handled. Lead time is the sum of queue, setup, run, wait, and move times.
Shop calendar. Another piece of information needed is the number of working
days available. The Gregorian calendar (which is the one we use every day) has some
serious drawbacks for manufacturing planning and control. The months do not have
the same number of days, holidays are spread unevenly throughout the year, and the
calendar does not work on a decimal base. Suppose the lead time for an item is
35 working days and on December 13 we are asked if we can deliver by January 22.
This is about six weeks away, but with the Gregorian calendar, some calculations have
to be made to decide if there is enough time to make the delivery. Holidays occur in
that period, and the plant will be shut down for inventory the first week in January.
How many working days do we really have?
Because of these problems, it is desirable to develop a shop calendar. This can
be set up in different ways, but the example shown in Figure 5.4 is typical.
CAPACITY AVAILABLE
Capacity available is the capacity of a system or resource to produce a quantity of
output in a given time period. It is affected by the following:
• Product specifications. If the product specifications change, the work content
(work required to make the product) will change, thus affecting the number of
units that can be produced.
• Product mix. Each product has its own work content measured in the time it
takes to make the product. If the mix of products being produced changes, the
total work content (time) for the mix will change.
131
Capacity Management
MONTH
WEEK
27
TUES.
WED.
2
3
4
123
127
16
29
30
JULY 2
18
24
142
2
123
130
134
138
135
139
1
143
WORK DAY
144
140
123
8
14
15
21
22
28
29
4
5
141
3
145
7
136
27
2
SUN.
131
20
26
SAT.
126
13
19
25
31
6
12
129
133
137
31
11
17
23
5
FRI.
125
128
132
30
THURS.
124
10
9
28
JULY
MON.
146
DEFINES NON-WORK DAYS
Figure 5.4 Planning calendar. (Source: The American Production and Inventory Control Society, Inc.,
Material Requirements Planning Training Aid, 5–21. Reprinted with permission.)
• Plant and equipment. This relates to the methods used to make the product. If
the method is changed—for example, a faster machine is used—the output will
change. Similarly, if more machines are added to the work center, the capacity
will change.
• Work effort. This relates to the speed or pace at which the work is done. If the
workforce changes pace, perhaps producing more in a given time, the capacity
will be altered.
Product specification and product mix depend on the design of the product and
the mix of products made. If these vary considerably, it is difficult to use units of
product to measure capacity. So what units should be used to measure capacity?
Measuring Capacity
Units of output. If the variety of products produced at a work center or in a plant
is not large, it is often possible to use a unit common to all products. Paper mills measure capacity in tons of paper, breweries in barrels of beer, and automobile manufacturers in numbers of cars. However, if a variety of products is made, a good common
unit may not exist. In this case, the unit common to all products is time.
Standard time. The work content of a product is expressed as the time required
to make the product using a given method of manufacture. Using time-study techniques, the standard time for a job can be determined—that is, the time it would take
132
Chapter 5
a qualified operator working at a normal pace to do the job. It provides a yardstick for
measuring work content and a unit for stating capacity. It is also used in loading and
scheduling.
Levels of Capacity
Capacity needs to be measured on at least three levels:
• Machine or individual worker.
• Work center.
• Plant, which can be considered as a group of different work centers.
Determining Capacity Available
There are two ways of determining the capacity available: measurement and calculation. Demonstrated (measured) capacity is figured from historical data. Calculated
or rated capacity is based on available time, utilization, and efficiency.
Rated capacity. Rated, or calculated, capacity is the product of available time, utilization, and efficiency.
Available time. The available time is the number of hours a work center can be
used. For example, a work center working one 8-hour shift for 5 days a week is available 40 hours a week. The available time depends on the number of machines, the
number of workers, and the hours of operation.
EXAMPLE PROBLEM
A work center has 3 machines and is operated for 8 hours a day 5 days a week. What
is the available time?
Answer
Available time = 3 * 8 * 5 = 120 hours per week
Utilization. The available time is the maximum hours we can expect from the work
center. However, it is unlikely this will be attained all the time. Downtime can occur
due to machine breakdown, absenteeism, lack of material, and all those problems
that cause unavoidable delays. The percentage of time that the work center is active
compared to the available time is called work center utilization:
Utilization =
hours actually worked
* 100%
available hours
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Capacity Management
EXAMPLE PROBLEM
A work center is available 120 hours but actually produced goods for 100 hours. What
is the utilization of the work center?
Answer
Utilization =
100
* 100% = 83.3%
120
Utilization can be determined from historical records or by a work sampling study.
Efficiency. It is possible for a work center to utilize 100 hours a week but not produce 100 standard hours of work. The workers might be working at a faster or slower
pace than the standard working pace, causing the efficiency of the work center to be
more or less than 100%:
Efficiency =
actual rate of production
* 100%
standard rate of production
EXAMPLE PROBLEM
A work center produces 120 units in a shift. The standard for that item is 100 units a
shift. What is the efficiency of the work center?
Answer
Efficiency =
120
* 100% = 120%
100
Rated capacity. Rated capacity is calculated by taking into account the work center utilization and efficiency:
Rated capacity = available time * utilization * efficiency
EXAMPLE PROBLEM
A work center consists of 4 machines and is operated 8 hours per day for 5 days a
week. Historically, the utilization has been 85% and the efficiency 110%. What is the
rated capacity?
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Chapter 5
Answer
Available time = 4 * 8 * 5 = 160 hours per week
Rated capacity = 160 * 0.85 * 1.10 = 149.6 standard hours
We expect to get 149.6 standard hours of work from that work center in an average
week.
Demonstrated Capacity
One way to find out the capacity of a work center is to examine the previous production records and to use that information as the available capacity of the work center.
EXAMPLE PROBLEM
Over the previous 4 weeks, a work center produced 120, 130, 150, and 140 standard
hours of work. What is the demonstrated capacity of the work center?
Answer
Demonstrated capacity =
120 + 130 + 150 + 140
= 135 standard hours
4
Notice that demonstrated capacity is average, not maximum, output. It also
depends on the utilization and efficiency of the work center, although these are not
included in the calculation.
Efficiency and utilization can be obtained from historical data if a record is
maintained of the hours available, hours actually worked, and the standard hours
produced by a work center.
EXAMPLE PROBLEM
Over a 4-week period, a work center produced 540 standard hours of work, was available for work 640 hours, and actually worked 480 hours. Calculate the utilization and
the efficiency of the work center.
Answer
hours actually worked
480
* 100 =
* 100% = 75%
available hours
640
standard hours of work produced
540
Efficiency =
* 100 =
* 100% = 112.5%
hours actually worked
480
Utilization =
135
Capacity Management
CAPACITY REQUIRED (LOAD)
Capacity requirements are generated by the priority planning system and involve
translating priorities, given in units of product or some common unit, into hours of
work required at each work center in each time period. This translation takes place
at each of the priority planning levels from production planning to master production scheduling to material requirements planning. Figure 5.2 illustrates this
relationship.
The level of detail, the planning horizon, and the techniques used vary with each
planning level. In this text, we will study the material requirements planning/capacity
requirements planning level.
Determining the capacity required is a two-step process. First, determine the
time needed for each order at each work center; then, sum up the capacity required
for individual orders to obtain the load.
Time Needed for Each Order
The time needed for each order is the sum of the setup time and the run time. The
run time is equal to the run time per piece multiplied by the number of pieces in
the order.
EXAMPLE PROBLEM
A work center is to process 150 units of gear shaft SG 123 on work order 333. The
setup time is 1.5 hours, and the run time is 0.2 hours per piece. What is the standard
time needed to run the order?
Answer
Total standard time = setup time + run time
= 1.5 + 1150 * 0.22
= 31.5 standard hours
EXAMPLE PROBLEM
In the previous problem, how much actual time will be needed to run the order if the
work center has an efficiency of 120% and a utilization of 80%?
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Chapter 5
Answer
Capacity required = 1actual time21efficiency21utilization2
Actual time =
=
capacity required
1efficiency21utilization2
31.5
11.2210.82
= 32.8 hours
Load
The load on a work center is the sum of the required times for all the planned and
actual orders to be run on the work center in a specified period. The steps in calculating load are as follows:
1. Determine the standard hours of operation time for each planned and released
order for each work center by time period.
2. Add all the standard hours together for each work center in each period. The
result is the total required capacity (load) on that work center for each time
period of the plan.
EXAMPLE PROBLEMS
A work center has the following open orders and planned orders for week 20.
Calculate the total standard time required (load) on this work center in week 20.
Order 222 is already in progress, and there are 100 remaining to run.
Released Orders
222
333
Planned Orders
444
555
Total Time
Order
Quantity
Setup Time
(hours)
Run Time
(hours/piece)
100
150
0
1.5
0.2
0.2
200
300
3
2.5
0.25
0.15
Total Time
(hours)
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Capacity Management
Answer
Released Orders 222 Total time =
333 Total time =
Planned Orders 444 Total time =
555 Total time =
0 + 1100 * 0.22
1.5 + 1150 * 0.22
3 + 1200 * 0.252
2.5 + 1300 * 0.152
=
=
=
=
20.0 standard hours
31.5 standard hours
53.0 standard hours
47.5 standard hours
= 152.0 standard hours
Total Time
In week 20, there is a load (requirement) for 152 standard hours.
The load must now be compared to the available capacity. One way of doing
this is with a work center load report.
Work Center Load Report
The work center load report shows future capacity requirements based on released
and planned orders for each time period of the plan.
The load of 152 hours calculated in the previous example is for week 20.
Similarly, loads for other weeks can be calculated and recorded on a load report such
as is shown in Figure 5.5. Figure 5.6 shows the same data in graphical form. Note that
the report shows released and planned load, total load, rated capacity and
(over)/under capacity. The term overcapacity means that the work center is overloaded and the term undercapacity means the work center is underloaded. This type
of display gives information used to adjust available capacity or to adjust the load by
changing the priority plan. In this example, weeks 20 and 21 are overloaded, the rest
are underloaded, and the cumulative load is less than the available. For the planner,
Week
20
21
22
23
24
Total
Released Load
51.5
45
30
30
25
181.5
Planned Load
100.5
120
100
90
100
510.5
Total Load
152
165
130
120
125
692
Rated Capacity
140
140
140
140
140
700
(Over)/Under
capacity
(12)
(25)
10
20
15
8
Figure 5.5 Work center load report.
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Chapter 5
Legend
200
Rated Capacity
Planned Load
Released Load
STANDARD HOURS
150
100
50
0
20
21
22
23
24
WEEKS
Figure 5.6 Graph of a load profile.
this shows there is enough total capacity over the planning horizon, and available
capacity or priority can be juggled to meet the plan.
SCHEDULING ORDERS
So far we have assumed that we know when an order should be run on one work
center. Most orders are processed across a number of work centers, and it is necessary to calculate when orders must be started and completed on each work center so
the final due date can be met. This process is called scheduling. In the eleventh
edition of the APICS Dictionary, a schedule is defined as “a timetable for planned
occurrences.”
Back scheduling. The usual process is to start with the due date and, using the
lead times, to work back to find the start date for each operation. This process is
called back scheduling. To schedule, we need to know for each order:
• Quantity and due date.
• Sequence of operations and work centers needed.
• Setup and run times for each operation.
Capacity Management
139
• Queue, wait, and move times.
• Work center capacity available (rated or demonstrated).
The information needed is obtained from the following:
• Order file. Quantities and due dates.
• Route file. Sequence of operations, work centers needed, setup time, and run time.
• Work center file. Queue, move, and wait times and work center capacity.
The process is as follows:
1. For each work order, calculate the capacity required (time) at each work
center.
2. Starting with the due date, schedule back to get the completion and start dates
for each operation.
EXAMPLE PROBLEM
Suppose there is an order for 150 of gear shaft SG 123. The due date is day 135. The
route sheet, shown in Figure 5.3, gives information about the operations to be performed and the setup and run times. The work center file, shown in Figure 5.7, gives
lead time data for each work center. Calculate the start and finish dates for each
operation. Use the following scheduling rules.
a. Operation times are rounded up to the nearest 8 hours and expressed as days
on a one-shift basis. That is, if an operation takes 6.5 standard hours, round it
up to 8 hours, which represents one day.
b. Assume an order starts at the beginning of the day and finishes at the end of a
day. For example, if an order starts on day 1 and is finished on day 5, it has
taken 5 days to complete. If move time is 1 day, the order will be available to the
next workstation at the start of day 7.
Answer
The calculations for the operation time at each work center are as follows:
Setup time + run time = total time 1standard hours2
Operation 10: Work center 12: 1.5 + 0.20 * 150 = 31.5 standard hours
= 4 days
Operation 20: Work center 14: 0.50 + 0.25 * 150 = 38.0 standard hours
= 5 days
Operation 30: Work center 17: 0.30 + 0.05 * 150 = 7.8 standard hours
= 1 day
Operation 40: Work center 03: 0.45 + 0.10 * 150 = 15.45 standard hours
= 2 days
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Chapter 5
The next step is to schedule back from the due date (day 135) to get the completion and start dates for each operation. To do so, we need to know not only the
operation times just calculated but also the queue, wait, and move times. These are in
the work center file. Suppose the information shown in Figure 5.7 is obtained from
these files.
The process starts with the last operation. The goods are to be in the stores on
day 135. It takes 1 day to move them, so the order must be completed on operation 40
on day 133. Subtracting the wait, queue, and operation times (11 days), the order
must be started on day 123. With a move time of 1 day, it must be completed on operation 30 on day 121. Using this process, the start and completion date can be calculated for all operations. Figure 5.8 shows the resulting schedule and Figure 5.9 shows
the same thing graphically.
Figure 5.7 Lead time data
from work center file.
Work Queue Time
Center
(days)
12
14
17
03
Wait Time
(days)
Move Time
(days)
1
1
1
1
1
1
1
1
4
3
5
8
Operation
Number
Work
Center
Arrival
Date
Queue
(days)
Operation
(days)
Wait
(days)
Finish
Date
10
12
95
4
4
1
103
20
14
105
3
5
1
113
30
17
115
5
1
1
121
40
3
123
8
2
1
133
50
Stores
135
Figure 5.8 Work schedule.
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Capacity Management
Work
Center
12
Operation 10
Operation 20
14
Operation 30
17
Operation 40
03
Stores
90
100
Release
Date
110
120
130
135
Due
Date
Figure 5.9 Work schedule.
MAKING THE PLAN
So far we have discussed the data needed for a capacity requirements plan, where the
data come from, and the scheduling and loading of shop orders through the various
work centers. The next step is to compare the load to available capacity to see if there
are imbalances and if so, to find possible solutions.
There are two ways of balancing capacity available and load: alter the load, or
change the capacity available. Altering the load means shifting orders ahead or back
so the load is leveled. If orders are processed on other work stations, the schedule
and load on the other work stations have to be changed as well. It may also mean that
other components should be rescheduled and the master production schedule
changed.
Consider the bill of material shown in Figure 5.10. If component B is to be
rescheduled to a later date, then the priority for component C is changed, as is the
master production schedule for A. For these reasons, changing the load may not be
the preferred course of action. In the short run, capacity can be adjusted. Some ways
that this may be done are as follows:
• Schedule overtime or undertime. This will provide temporary and quick relief
for cases where the load/capacity imbalance is not too large.
• Adjust the level of the workforce by hiring or laying off workers. The ability to
do so will depend on the availability of the skills required and the training
needed. The higher the skill level and the longer the training needed, the more
difficult it becomes to change quickly the level of the workforce.
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Chapter 5
Figure 5.10 Simple bill of
material.
A
B
C
• Shift workforce from underloaded to overloaded work centers. This requires a
flexible cross-trained workforce.
• Use alternate routings to shift some load to another work center. Often the
other work center is not as efficient as the original. Nevertheless, the important
thing is to meet the schedule, and this is a valid way of doing so.
• Subcontract work when more capacity is needed or bring in previously subcontracted work to increase required capacity. It may be more costly to subcontract
rather than make the item in-house, but again it is important to maintain the
schedule.
The result of capacity requirements planning should be a detailed workable
plan that meets the priority objectives and provides the capacity to do so. Ideally, it
will satisfy the material requirements plan and allow for adequate utilization of the
workforce, machinery, and equipment.
SUMMARY
Capacity management occurs at all levels of the planning process. It is directly related
to the priority plan, and the level of detail and time spans will be similar to the related
priority plan.
Capacity planning is concerned with translating the priority plan into the hours
of capacity required in manufacturing to make the items in the priority plan and with
methods of making that capacity available. Capacity available depends upon the
number of workers and machines, their utilization, and efficiency.
Capacity requirements planning occurs at the material requirements planning
level. It takes planned orders from the MRP and open shop orders from the open
order file and converts them to a load on each work center. It considers lead times
and actual order quantities. It is the most detailed of the capacity planning
techniques.
Material requirements planning and capacity requirements planning should
form part of a closed-loop system that not only includes planning and control functions but also provides feedback so planning can always be current. Figure 5.11 illustrates the concept.
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Capacity Management
MPS
No
FEEDBACK
CAPACITY OKAY?
(ROUGH CUT)
Yes
No
FEEDBACK
MRP
CAPACITY OKAY?
(CRP)
Yes
PURCHASING
PRODUCTION
ACTIVITY
CONTROL
PERFORMANCE MEASURES
Figure 5.11 MRP and CRP closed-loop system.
KEY TERMS
Capacity required 126
Load 126
Capacity management 126
Capacity planning 126
Capacity control 126
Resource planning 127
Rough-cut capacity
planning 127
Capacity requirements
planning 127
Open order file 129
Work center file 130
Move time 130
Wait time 130
Queue time 130
Lead time 130
Shop calendar 130
Capacity available 130
Standard time 131
Demonstrated (measured)
capacity 132
Calculated or rated
capacity 132
Available time 132
Utilization 132
Efficiency 133
Scheduling 138
Back scheduling 138
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Chapter 5
QUESTIONS
1. What are the responsibilities of capacity management?
2. What is capacity planning?
3. Describe the three steps of capacity planning.
4. Relate the three levels of priority planning to capacity planning. Describe each level in
terms of the detail and the time horizons used.
5. What is capacity requirements planning? At what level of the priority planning process
does it occur?
6. What are the inputs to the CRP process? Where is this information obtained?
7. Describe each of the following and the information they contain.
a. Open order file.
b. Route file.
c. Work center file.
8. What is a shop calendar? Why is it needed?
9. In which file would you find the following information?
a. A scheduled receipt.
b. A planned receipt.
c. Efficiency and utilization.
d. Sequence of operations on a part.
10. Define capacity available. What are the four factors that affect it?
11. Why is standard time usually used to measure capacity?
12. What are rated capacity, utilization, and efficiency? How are they related?
13. What is measured or demonstrated capacity? How is it different from rated capacity?
14. What is load?
15. What is a work center load report? What information does it contain?
16. What is a schedule?
17. Describe the process of back scheduling.
18. What are the two ways of balancing capacity available and load? Which is preferred? Why?
19. What are some of the ways capacity available can be altered in the short run?
20. Why is feedback necessary in a control system?
21. What might be some of the problems in scheduling rated capacity too closely to the load?
PROBLEMS
5.1
A work center consists of 4 machines each working a 16-hour day for 5 days a week.
What is the weekly available time?
Answer.
320 hours per week
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Capacity Management
5.2
The work center in problem 5.1 is utilized 75% of the time. What are the hours per week
actually worked?
Answer.
5.3
If the efficiency of the work center in problem 5.1 is 115%, what is the rated capacity of
the work center?
Answer.
5.4
240 hours per week
276 standard hours per week
A work center consisting of 7 machines is operated 16 hours a day for a 5-day week.
Utilization is 80%, and efficiency is 110%. What is the rated weekly capacity in standard
hours?
Answer.
492.8 standard hours per week
5.5
A work center consists of 3 machines working 8 hours a day for a 5-day week. If the
utilization is 75% and the efficiency is 125%, what is the rated capacity of the work
center?
5.6
Over a period of 4 weeks, a work center produced 50, 45, 40, and 55 standard hours of
work. What is the demonstrated capacity of the work center?
Answer.
47.5 standard hours of work per week
5.7
In an 11-week period, a work center produces 1000 standard hours of work. What is the
measured capacity of the work center?
5.8
In 1 week, a work center produces 85 standard hours of work. The hours scheduled are
80, and 75 hours are actually worked. Calculate the utilization and efficiency of the work
center.
Answer.
5.9
Utilization is 93.75%; efficiency is 113.33%
A work center consisting of 3 machines operates 40 hours a week. In a 4-week period, it
actually worked 360 hours and produced 468 standard hours of work. Calculate the utilization and efficiency of the work center. What is the demonstrated weekly capacity of
the work center?
5.10 A firm wishes to determine the efficiency and utilization of a work center composed of 3
machines each working 16 hours per day for 5 days a week. A study undertaken by the
materials management department found that over the past year the work center was
available for work 12,000 hours, work was actually being done for 10,000 hours, and
work was performed 11,480 standard hours. Calculate the utilization, efficiency, and
demonstrated weekly capacity. Assume a 50-week year.
5.11 How many standard hours are needed to run an order of 200 pieces if the setup time is
1.3 hours and the run time 0.3 hours per piece? How many actual hours are needed at
the work center if the efficiency is 130% and the utilization is 70%?
Answer.
61.3 standard hours; 67.4 actual hours
5.12 How many standard hours are needed to run an order of 500 pieces if the setup time is
2.0 hours and the run time 0.2 hours per piece? How many actual hours are needed at
the work center if the efficiency is 120% and the utilization is 75%?
5.13 A work center has the following open and planned orders for week 4. Calculate the total
standard time required (load).
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Chapter 5
Released Orders
Planned Orders
Order
Quantity
Setup time
(hours)
Run time
(hours/piece)
120
300
1.00
0.10
340
200
2.50
0.30
560
300
3.00
0.25
780
500
2.00
0.15
Total time
(hours)
Total Time (standard hours)
Answer.
Total time = 248.5 standard hours
5.14 A work center has the following open and planned orders for week 4. Calculate the total
standard time required (load).
Released Orders
Planned Orders
Order
Quantity
Setup time
(hours)
Run time
(hours/piece)
125
200
0.25
0.10
345
70
0.40
0.05
565
80
1.00
0.20
785
35
0.50
0.15
Total time
(hours)
Total Time (standard hours)
5.15 Using the information in the following route file, open order file, and MRP planned
orders, calculate the load on the work center.
Routing:
Part 123:
Part 456:
Setup time
Run time per piece
Setup time
Run time per piece
=
=
=
=
2 standard hours
3 standard hours per piece
3 standard hours
1 standard hour per piece
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Capacity Management
Planned Orders for parts
Open Orders for parts
1
2
3
1
2
3
123
12
8
5
0
5
10
456
15
5
5
0
10
15
Week
Load report
Week
1
2
3
Released Load 123
456
Planned Load
123
456
Total Load
5.16 Complete the following load report and suggest possible courses of action.
Week
Released Load
Planned Load
18
19
20
21
Total
150
155
100
70
475
0
0
80
80
160
150
150
150
150
600
Total Load
Rated Capacity
(Over)/Under
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Chapter 5
5.17 Back schedule the following shop order. All times are given in days. Move time between
operations is 1 day, and wait time is 1 day. Due date is day 150. Assume orders start at
the beginning of a day and finish at the end of a day.
Operation
Number
Work
Center
Operation
Time (days)
Queue Time
(days)
10
111
2
3
20
130
4
5
30
155
1
2
Stores
Answer.
Arrival
Date
Finish
Date
150
The order must arrive at work center 111 on day 127.
5.18 Back schedule the following shop order. All times are given in days. Move time between
operations is 1 day, and wait time is 1 day. Due date is day 200. Assume orders start at
the beginning of a day and finish at the end of a day.
Operation
Number
Work
Center
Operation
Time (days)
Queue Time
(days)
10
110
4
3
20
120
2
4
30
130
3
2
Stores
Arrival
Date
200
Finish
Date
Capacity Management
149
WESCOTT PRODUCTS
Whenever Jason Roberts thought about going to work on Friday morning, he started
to get a little knot in his stomach. Jason had recently accepted the job as operations
manager for a small manufacturing company that specialized in a line of assemble-toorder products. When he accepted the job he was a recent graduate of a business program where he specialized in operations. He had done fairly well in his classes and
had emerged as a confident, self-assured person who was sure he could handle such a
job in a small company.
The company, Wescott Products, had recently experienced rapid growth from the
original start in a two-car garage just five years earlier. In fact, Jason was the first person
ever named as operations manager. Prior to that, the only production “manager” reporting to the owner (Judy Wescott) was Frank Adams, the production supervisor. While
Frank was an experienced supervisor, he had been promoted to supervisor directly
from his old job as a machine operator and had no formal training in planning and
control. He soon found that planning was too complex and difficult for him to handle,
especially since he also had full responsibility for all the Wescott workers and equipment. Randy Stockard, the sales and marketing manager, had requested and finally
applauded Judy Wescott’s decision to hire Jason, since he felt production was having
a much more difficult time in promising and delivering customer orders. Randy was
starting to spend more and more time on the phone with angry customers when they
didn’t get their orders at the time they expected them. The time away from developing new sales and the danger of losing established customers started to make him
highly concerned about sustaining sales growth, to say nothing about his potential
bonus check tied to new sales!
Once Jason was placed in the position, however, the “honeymoon” was short,
and soon Jason started doubting how much he really did know. The company was still
having trouble with promising customer orders and having the capacity to meet those
orders. At first he thought it was the forecasting method he used, but a recent analysis
told him the total actual orders were generally within 10% of what the forecast projected. In addition, production never seemed to have any significant shortages in
either subassemblies or components. In fact, many felt they had far too much material, and in the last couple of staff meetings Jake Marris (the company controller) was
grumbling that he thought the inventory turn ratio of just less than 3.5 was unreasonable and costing the company a lot of money. It must be something else, and he had
to discover it quickly.
The first idea he thought about was to request the assembly areas to work overtime, but he soon found out that was a sensitive topic that was to be used as a last
resort. The workers in that area were highly skilled and would be difficult, if not
impossible, to replace in any reasonable time. Adding more would also be difficult for
the same reason. A year earlier they were being worked a lot of overtime but had
finally had enough. Even though Wescott had no union, the workers got together and
demanded better overtime control or they would all quit to move to other jobs that
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Chapter 5
were plentiful for skilled workers in this area. The agreement was that they were to be
asked for no more than four hours of overtime per worker per week unless it was
truly an emergency situation. They were well paid and all had families, and the time
with their families was worth more to them than additional overtime pay. At least the
high skill level had one advantage: Each of the workers in the assembly area could
skillfully assemble any of the models, and the equipment each had was flexible
enough to handle all the models.
Friday mornings were when Jason made his master schedule for the next week
(since the standard lead time for all assemblies was quoted as one week, the company
had felt no need to schedule farther into the future when very few orders existed there),
and no matter how hard he tried he never seemed to be able to get it right. He was sure
that he had to start the process by loading the jobs that were missed in the current week
into the Monday and Tuesday time blocks and then hope that production could catch
up with those in addition to the new jobs that were already promised. The promises
came when Randy would inform him of a customer request and ask for a promise
date—which was often “as soon as possible.” Jason would look at the order to see if the
material to make it was in stock and if the equipment to make it was running. He would
then typically promise to have it available when requested. Now that a lot of promises
were not being met, however, Randy was starting to demand that Jason “get control” of
the operation. Jason tried to respond by scheduling a lot of each model to be run every
week, but he often found he had to break into the run of a lot to respond to expediting
from sales. He knew this made matters worse by using extra time to set up the equipment, but what else could he do? Even Judy Wescott was asking him what she needed
to do to help him improve the performance. His normal high level of self-confidence
was being shaken.
Jason started pouring over his old operations book looking for something he
could use. He finally realized that what he needed was a more effective system to
develop master schedules from which he could promise orders, order components,
and plan capacity. Unfortunately, he also recalled that when that material was covered in his class he had taken off early for spring break! Even though he knew enough
to recognize the nature of the problem, he didn’t know enough to set up such a schedule. Humbly, he called his former instructor to ask for advice. Once she was briefed
on the problem, she told him to gather some information that he could use to develop
a sample master schedule and rough-cut capacity plan. Once he had the information,
she would help show him how to use it.
The following describes what she asked him to collect:
1. Pick a work center or piece of equipment that has caused some capacity
problem in the recent past. List all the product models that use that work
center.
2. For each of the models, list the amount of run time they use the work center per
item. Also list the setup time, if any. These times can be gathered from standards or, if the standard data are suspect in their accuracy or do not exist, use
the actual average time from recent production.
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Capacity Management
3. For each of the models, list the usual lot size. This should be the same lot size
used for the master schedule.
4. For each of the models, list the current inventory, the current forecast, and the
current firm customer order quantities.
5. The current capacity (hours) available for the equipment.
The following tables summarize the data he collected:
WORK CENTER 12
Model
Run Time (per
item, in minutes)
A
B
C
D
E
3.7
5.1
4.3
8.4
11.2
Setup Time
(per lot)
Lot Size
(minimum qty.)
*On-hand
90 minutes
40 minutes
60 minutes
200 minutes
120 minutes
150
100
120
350
400
10
0
0
22
153
*
Most of the on-hand was really forced when the lot size exceeded orders for the
week for that model. They would then assemble the rest of the lot as “plain vanilla,”
such that they could easily add any subassembly options once the actual customer
orders came in.
Two workers are currently assigned to the work center, assigned only to the first
shift. Even though assembly workers are very flexible, he cannot take workers from
another assembly area, as those work centers are also behind and therefore appear to
be equally overloaded.
The following is the forecast and customer orders for each of the five models
assembled in work center 12:
Model
Weeks
1
2
3
4
5
6
7
8
9
10
A
Forecast
Customer Orders
Forecast
Customer Orders
Forecast
Customer Orders
Forecast
Customer Orders
Forecast
Customer Orders
45
53
35
66
50
52
180
277
200
223
45
41
35
40
50
43
180
190
200
174
45
22
35
31
50
33
180
178
200
185
45
15
35
30
50
21
180
132
200
109
45
4
35
17
50
14
180
94
200
74
45
7
35
6
50
4
180
51
200
36
45
2
35
2
50
7
180
12
200
12
45
0
35
0
50
1
180
7
200
2
45
0
35
0
50
0
180
9
200
0
45
0
35
0
50
0
180
2
200
0
B
C
D
E
Once he had gathered all the data, he immediately called his instructor, only to
find out that by an ironic twist of fate she would be gone for more than a week on
spring break!
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Chapter 5
Assignment
This leaves you to help Jason. Specifically, you need to do the following:
1. Discuss the nature and probable sources of the problem here.
2. Examine the rough-cut capacity situation using the data Jason gathered. Discuss
the results and how they are linked to the problems identified in question 1.
3. Use the information and your knowledge of the situation to develop a complete
plan for Jason to use in the future. Part of this plan should be to build and
demonstrate the approach to master scheduling for the data given in the case.
6
Production Activity Control
INTRODUCTION
The time comes when plans must be put into action. Production activity control
(PAC) is responsible for executing the master production schedule and the material
requirements plan. At the same time, it must make good use of labor and machines,
minimize work-in-process inventory, and maintain customer service.
The material requirements plan authorizes PAC:
• To release work orders to the shop for manufacturing.
• To take control of work orders and make sure they are completed on time.
• To be responsible for the immediate detailed planning of the flow of orders
through manufacturing, carrying out the plan, and controlling the work as it
progresses to completion.
• To manage day-to-day activity and provide the necessary support.
Figure 6.1 shows the relationship between the planning system and PAC.
The activities of the PAC system can be classified into planning, implementation, and control functions.
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PRODUCTION
PLANNING
MASTER
PRODUCTION
SCHEDULE
PLANNING
MATERIAL
REQUIREMENTS
PLAN
IMPLEMENTION
AND
CONTROL
PURCHASING
PRODUCTION
ACTIVITY
CONTROL
INPUT/
OUTPUT
CONTROL
OPERATION
SEQUENCING
Figure 6.1 Priority planning and production activity control.
Planning
The flow of work through each of the work centers must be planned to meet delivery
dates, which means production activity control must do the following:
• Ensure that the required materials, tooling, personnel, and information are
available to manufacture the components when needed.
• Schedule start and completion dates for each shop order at each work center so
the scheduled completion date of the order can be met. This will involve the
planner in developing a load profile for the work centers.
Implementation
Once the plans are made, production activity control must put them into action by
advising the shop floor what must be done. Usually instructions are given by issuing a
shop order. Production activity control will:
• Gather the information needed by the shop floor to make the product.
• Release orders to the shop floor as authorized by the material requirements
plan. This is called dispatching.
155
Production Activity Control
Figure 6.2 Schematic of a
production control system.
PRODUCTION ACTIVITY CONTROL
PLAN
Schedule
Replan
IMPLEMENT
Work
Authorization
CONTROL
Compare
Decide
Dispatch
Feedback
MANUFACTURING OPERATIONS
Control
Once plans are made and shop orders released, the process must be monitored to learn
what is actually happening. The results are compared to the plan to decide whether corrective action is necessary. Production activity control will do the following:
• Rank the shop orders in desired priority sequence by work center and establish
a dispatch list based on this information.
• Track the actual performance of work orders and compare it to planned schedules. Where necessary, PAC must take corrective action by replanning, rescheduling, or adjusting capacity to meet final delivery requirements.
• Monitor and control work-in-process, lead times, and work center queues.
• Report work center efficiency, operation times, order quantities, and scrap.
The functions of planning, implementing, and controlling are shown schematically in Figure 6.2.
Manufacturing Systems
The particular type of production control system used varies from company to company, but all should perform the preceding functions. However, the relative importance
of these functions will depend on the type of manufacturing process. Manufacturing
processes can be conveniently organized into three categories:
1. Flow manufacturing.
2. Intermittent manufacturing.
3. Project manufacturing.
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Flow manufacturing. Flow manufacturing is concerned with the production of
high-volume standard products. If the units are discrete (e.g., cars and appliances),
the process is usually called repetitive manufacturing, and if the goods are made in a
continuous flow (e.g., gasoline), the process is called continuous manufacturing.
There are four major characteristics to flow manufacturing:
1. Routings are fixed, and work centers are arranged according to the routing. The
time taken to perform work at one work center is almost the same as at any
other work center in the line.
2. Work centers are dedicated to producing a limited range of similar products.
Machinery and tooling are especially designed to make the specific products.
3. Material flows from one workstation to another using some form of mechanical
transfer. There is little buildup in work-in-process inventory, and throughput
times are low.
4. Capacity is fixed by the line.
Production activity control concentrates on planning the flow of work and making sure that the right material is fed to the line as stated in the planned schedule.
Since work flows from one workstation to another automatically, implementation
and control are relatively simple.
Intermittent manufacturing. Intermittent manufacturing is characterized by
many variations in product design, process requirements, and order quantities. This
kind of manufacturing is characterized by the following:
1. Flow of work through the shop is varied and depends on the design of a particular product. As orders are processed, they will take more time at one workstation than at another. Thus, the work flow is not balanced.
2. Machinery and workers must be flexible enough to do the variety of work.
Machinery and work centers are usually grouped according to the function they
perform (e.g., all lathes in one department).
3. Throughput times are generally long. Scheduling work to arrive just when
needed is difficult, the time taken by an order at each work center varies, and
work queues before work centers, causing long delays in processing. Work-inprocess inventory is often large.
4. The capacity required depends on the particular mix of products being built and
is difficult to predict.
Production activity control in intermittent manufacturing is complex. Because
of the number of products made, the variety of routings, and scheduling problems,
PAC is a major activity in this type of manufacturing. Planning and control are typically exercised using shop orders for each batch being produced. Our discussion of
PAC assumes this kind of environment.
Production Activity Control
157
Project manufacturing. Project manufacturing usually involves the creation of
one or a small number of units. Large shipbuilding is an example. Because the design
of a product is often carried out or modified as the project develops, there is close
coordination between manufacturing, marketing, purchasing, and engineering.
DATA REQUIREMENTS
To plan the processing of materials through manufacturing, PAC must have the following information:
• What and how much to produce.
• When parts are needed so the completion date can be met.
• What operations are required to make the product and how long the operations
will take.
• What the available capacities of the various work centers are.
Production activity control must have a data or information system from which
to work. Usually the data needed to answer these questions are organized into databases. The files contained in the databases are of two types: planning and control.
Planning Files
Four planning files are needed: item master file, product structure file, routing file,
and work center master file.
Item master file. There is one record in the item master file for each part number. The file contains, in one place, all of the pertinent data related to the part. For
PAC, this includes the following:
•
•
•
•
•
•
Part number, a unique number assigned to a component.
Part description.
Manufacturing lead time, the normal time needed to make this part.
Quantity on hand.
Quantity available.
Allocated quantity, quantities assigned to specific work orders but not yet withdrawn from inventory.
• On-order quantities, the balance due on all outstanding orders.
• Lot-size quantity, the quantity normally ordered at one time.
Product structure file (bill of material file). The product structure file (bill of
material file) contains a list of the single-level components and quantities needed to
assemble a parent. It forms a basis for a “pick list” to be used by storeroom personnel
to collect the parts required to make the assembly.
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Routing file. The routing file contains a record for each part manufactured. The
routing consists of a series of operations required to make the item. For each product, this file contains a step-by-step set of instructions describing how the product is
made. It gives details of the following:
• The operations required to make the product and the sequence in which those
operations are performed.
• A brief description of each operation.
• Equipment, tools, and accessories needed for each operation.
• Setup times, the standard time required for setting up the equipment for each
operation.
• Run times, the standard time required to process one unit through each operation.
• Lead times for each operation.
Work center master file. The work center master file collects all of the relevant
data on a work center. For each work center, it gives details on the following:
•
•
•
•
•
•
•
•
Work center number.
Capacity.
Number of shifts worked per week.
Number of machine hours per shift.
Number of labor hours per shift.
Efficiency.
Utilization.
Queue time, the average time that a job waits at the work center before work is
begun.
• Alternate work centers, work centers that may be used as alternatives.
Control Files
Control in intermittent manufacturing is exercised through shop orders and control
files that contain data on these orders. There are generally two kinds of files: the shop
order master file and the shop order detail file.
Shop order master file. Each active manufacturing order has a record in the
shop order master file. The purpose is to provide summarized data on each shop
order, such as the following information:
•
•
•
•
Shop order number, a unique number identifying the shop order.
Order quantity.
Quantity completed.
Quantity scrapped.
Production Activity Control
•
•
•
•
•
159
Quantity of material issued to the order.
Due date, the date the order is expected to be finished.
Priority, a value used to rank the order in relation to others.
Balance due, the quantity not yet completed.
Cost information.
Shop order detail file. Each shop order has a shop order detail file contains a
record for each operation needed to make the item. Each record contains the following information:
•
•
•
•
•
•
Operation number.
Setup hours, planned and actual.
Run hours, planned and actual.
Quantity reported complete at that operation.
Quantity reported scrapped at that operation.
Due date or lead time remaining.
ORDER PREPARATION
Once authorization to process an order has been received, production activity control
is responsible for planning and preparing its release to the shop floor. The order
should be reviewed to be sure that the necessary tooling, material, and capacity are
available. If they are not, the order cannot be completed and should not be released.
Tooling is not generally considered in the material requirements planning
(MRP) program, so at this stage, material availability must be checked. If MRP software is used, it will have checked the availability of material and allocated it to a shop
order so no further checking is necessary. If MRP software is not used, production
activity control must manually check material availability.
If a capacity requirements planning system has been used, necessary capacity
should be available. However, at this stage, there may be some differences between
planned capacity and what is actually available. When capacity requirements planning is not used, it is necessary to determine if capacity is available.
Checking capacity availability is a two-step process. First, the order must be scheduled to see when the capacity is needed, and second, the load on work centers must be
checked in that period. Scheduling and loading are discussed in the next two sections.
SCHEDULING
The objective of scheduling is to meet delivery dates and to make the best use of manufacturing resources. It involves establishing start and finish dates for each operation
required to complete an item. To develop a reliable schedule, the planner must have
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information on routing, required and available capacity, competing jobs, and manufacturing lead times (MLT) at each work center involved.
Manufacturing Lead Time
Manufacturing lead time is the time normally required to produce an item in a typical lot quantity. Typically, MLT consists of five elements:
1. Queue time, amount of time the job is waiting at a work center before operation
begins.
2. Setup time, time required to prepare the work center for operation.
3. Run time, time needed to run the order through the operation.
4. Wait time, amount of time the job is at the work center before being moved to
the next work center.
5. Move time, transit time between work centers.
The total manufacturing lead time will be the sum of order preparation and
release plus the MLTs for each operation. Figure 6.3 shows the elements making up
manufacturing lead time. Setup time and run time are straightforward, and determining them is the responsibility of the industrial engineering department. Queue, wait,
and move times are under the control of manufacturing and PAC.
The largest of the five elements is queue time. Typically, in an intermittent manufacturing operation, it accounts for 85%–95% of the total lead time. Production activity
control is responsible for managing the queue by regulating the flow of work into and
out of work centers. If the number of orders waiting to be worked on (load) is reduced,
so is the queue time, the lead time, and work-in-process. Increasing capacity also
reduces queue. Production activity control must manage both the input of orders to the
production process and the available capacity to control queue and work-in-process.
A term that is closely related to manufacturing lead time is cycle time. The
eleventh edition of the APICS Dictionary defines cycle time as “the length of time from
when material enters a production facility until it exits.” A synonym is throughput time.
ORDER
RELEASE
QUEUE
SETUP
RUN
WAIT
QUEUE
SETUP
RUN
WAIT
Figure 6.3 Manufacturing lead time.
MOVE
MOVE
QUEUE
SETUP
RUN
WAIT
QUEUE
SETUP
RUN
WAIT
MOVE
MOVE
Production Activity Control
161
EXAMPLE PROBLEM
An order for 100 of a product is processed on work centers A and B. The setup time
on A is 30 minutes, and run time is 10 minutes per piece. The setup time on B is 50
minutes, and the run time is 5 minutes per piece. Wait time between the two operations is 4 hours. The move time between A and B is 10 minutes. Wait time after operation B is 4 hours, and the move time into stores is 15 minutes. There is no queue at
either workstation. Calculate the total manufacturing lead time for the order.
Answer
Work Center A operation time 30 (100 10) 1030 minutes
Wait time
240 minutes
Move time from A to B
10 minutes
Work Center B operation time 50 (100 5) 550 minutes
Wait time
240 minutes
Move time from B to stores
15 minutes
Total manufacturing lead time
2085 minutes
34 hours, 45 minutes
Scheduling Techniques
There are many techniques to schedule shop orders through a plant, but all of them
require an understanding of forward and backward scheduling as well as finite and
infinite loading.
Forward scheduling assumes that material procurement and operation scheduling
for a component start when the order is received, whatever the due date, and that operations are scheduled forward from this date. The first line in Figure 6.4 illustrates this
method. The result is completion before the due date, which usually results in a buildup
of inventory. This method is used to decide the earliest delivery date for a product.
Forward scheduling is used to calculate how long it will take to complete a task.
The technique is used for purposes such as developing promise dates for customers
or figuring out whether an order behind schedule can be caught up.
Backward scheduling is illustrated by the second line in Figure 6.4. The last
operation on the routing is scheduled first and is scheduled for completion at the due
date. Previous operations are scheduled back from the last operation. This schedules
items to be available as needed and is the same logic as used in the MRP system.
Work-in-process inventory is reduced, but because there is little slack time in the system, customer service may suffer.
Backward scheduling is used to determine when an order must be started.
Backward scheduling is common in industry because it reduces inventory.
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Order Received
1
2
Due Date
3
4
5
6
7
8
9
Forward Scheduling
Material
Ordered
1st
operation
2nd
operation
3rd
operation
Backward Scheduling
Material
Ordered
1st
operation
2nd
operation
3rd
operation
Figure 6.4 Forward and backward scheduling: infinite loading.
Infinite loading is also illustrated in Figure 6.4. The assumption is made that
the workstations on which operations 1, 2, and 3 are done have capacity available
when required. It does not consider the existence of other shop orders competing
for capacity at these work centers. It assumes infinite capacity will be available.
Figure 6.5 shows a load profile for infinite capacity. Notice the over- and underload.
Finite loading assumes there is a defined limit to available capacity at any workstation. If there is not enough capacity available at a workstation because of other
shop orders, the order has to be scheduled in a different time period. Figure 6.6 illustrates the condition.
In the forward-scheduling example shown in Figure 6.6, the first and second
operations cannot be performed at their respective workstations when they should be
because the required capacity is not available at the time required. These operations
Figure 6.5 Infinite load
profile.
Capacity Overload
CAPACITY
Capacity Underload
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Production Activity Control
Order Received
1
2
Due Date
3
4
5
6
7
8
9
Forward Scheduling
Material
Ordered
1st
operation
2nd
3rd
operation operation
Backward Scheduling
Material
Ordered
1st
operation
2nd
operation
3rd
operation
Figure 6.6 Forward and backward scheduling: finite loading.
Figure 6.7 Finite load
profile.
CAPACITY
Smoothed Load
must be rescheduled to a later time period. Similarly, in the example of scheduling
back, the second and first operations cannot be performed when they should be and
must be rescheduled to an earlier time period. Figure 6.7 shows a load profile for
finite loading. Notice the load is smoothed so there is no overload condition.
Chapter 5 gives an example of backward scheduling as it relates to capacity
requirements planning. The same process is used in PAC.
EXAMPLE PROBLEM
A company has an order for 50 brand X to be delivered on day 100. Draw a backward
schedule based on the following:
a. Only one machine is assigned to each operation
b. The factory works one 8-hour shift 5 days a week
c. The parts move in one lot of 50.
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Chapter 6
X
A
B
Part
Operation
Time
A
10
5
A
20
3
B
10
10
X
Assembly
5
Answer
Part A
OP 10
OP 20
X
Assembly
Part B
OP 10
85
90
95
100
WORKING DAYS
Operation Overlapping
In operation overlapping, the next operation is allowed to begin before the entire lot
is completed on the previous operation. This reduces the total manufacturing lead
times because the second operation starts before the first operation finishes all the
parts in the order. Figure 6.8 shows schematically how it works and the potential
reduction in lead time.
An order is divided into at least two lots. When the first lot is completed on
operation A, it is transferred to operation B. In Figure 6.8, it is assumed operation B
cannot be set up until the first lot is received, but this is not always the case. While
Operation A
SU
LOT 1
LOT 2
T
T
SU
Operation B
Figure 6.8 Operation overlapping.
LOT 1
Transit Time
LOT 2
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Production Activity Control
operation A continues with the second lot, operation B starts on the first lot. When
operation A finishes the second lot, it is transferred to operation B. If the lots are
sized properly, there will be no idle time at operation B. The manufacturing lead time
is reduced by the overlap time and the elimination of queue time.
Operation overlapping is a method of expediting an order, but there are some
costs involved. First, move costs are increased, especially if the overlapped operations
are not close together. Second, it may increase the queue and lead time for other
orders. Third, it does not increase capacity but potentially reduces it if the second
operation is idle waiting for parts from the first operation.
The problem is deciding the size of the sublot. If the run time per piece on operation B is shorter than that on A, the first batch must be large enough to avoid idle
time on operation B.
EXAMPLE PROBLEM
Refer to the data given in the example problem in the section on manufacturing lead
time. It is decided to overlap operations A and B by splitting the lot of 100 into two lots
of 70 and 30. Wait time between A and B and between B and stores is eliminated. The
move times remain the same. Setup on operation B cannot start until the first batch
arrives. Calculate the manufacturing lead time. How much time has been saved?
Answer
Operation time for A for lot of 70 = 30 + (70 10) = 730
Move time between A and B
= 10
Operation time for B for lot of 100 = 50 + (100 5) = 550
Move time from B to stores
= 15
Total manufacturing lead time
= 1305
= 21
Time saved = 2085 – 1305 = 780 minutes
= 13
minutes
minutes
minutes
minutes
minutes
hours, 45 minutes
hours
Operation Splitting
Operation splitting is a second method of reducing manufacturing lead time. The order
is split into two or more lots and run on two or more machines simultaneously. If the
lot is split in two, the run-time component of lead time is effectively cut in half, although
an additional setup is incurred. Figure 6.9 shows a schematic of operation splitting.
Operation splitting is practical when:
• Setup time is low compared to run time.
• A suitable work center is idle.
• It is possible for an operator to run more than one machine at a time.
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Chapter 6
Figure 6.9 Operation splitting.
Single Machine
SU
RUN
2 Machine Operation Splitting
SU
RUN
Reduction
in Lead
Time
SU
RUN
The last condition often exists when a machine cycles through its operation
automatically, leaving the operator time to set up another machine. The time
needed to unload and load must be shorter than the run time per piece. For example, if the unload/load time was two minutes and the run time was three minutes, the
operator would have time to unload and load the first machine while the second was
running.
EXAMPLE PROBLEM
A component made on a particular work center has a setup time of 100 minutes and
a run time of 3 minutes per piece. An order for 500 is to be processed on 2 machines
simultaneously. The machines can be set up at the same time. Calculate the elapsed
operation time.
Answer
Elapsed operation time = 100 + 3 * 250 = 850 minutes
= 14 hours and 10 minutes
LOAD LEVELING
Load profiles were discussed in Chapter 5 in the section on capacity requirements
planning. The load profile for a work center is constructed by calculating the standard
hours of operation for each order in each time period and adding them together by
time period. Figure 6.10 is an example of a load report.
This report tells PAC what the load is on the work center. There is a capacity
shortage in week 20 of 30 hours. This means there was no point in releasing all of the
planned orders that week. Perhaps some could be released in week 18 or 19, and perhaps some overtime could be worked to help reduce the capacity crunch.
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Production Activity Control
Work Center: 10
Description: Lathes
Number of Machines: 3
Rated Capacity:
110 standard hours/week
Week
Available Time: 120 hours/week
Efficiency: 115%
Utilization 80%
18
19
20
21
22
23
Total
Released Load
Planned Load
105
100
80
60
30
80
0
130
0
80
315
350
Total Load
105
100
140
110
130
80
665
Rated Capacity
110
110
110
110
110
110
660
5
10
(30)
(20)
30
(Over)/Under
Capacity
0
(5)
Figure 6.10 Work center load report.
SCHEDULING BOTTLENECKS
In intermittent manufacturing, it is almost impossible to balance the available capacities of the various workstations with the demand for their capacity. As a result, some
workstations are overloaded and some underloaded. The overloaded workstations
are called bottlenecks and, by definition, are those workstations where the required
capacity is greater than the available capacity. In the eleventh edition of its dictionary, APICS defines a bottleneck as “a facility, function, department, or resource
whose capacity is equal to or less than the demand placed upon it.”
Throughput. Throughput is the total volume of production passing through a
facility. Bottlenecks control the throughput of all products processed by them. If
work centers feeding bottlenecks produce more than the bottleneck can process,
excess work-in-process inventory is built up. Therefore, work should be scheduled
through the bottleneck at the rate it can process the work. Work centers fed by bottlenecks have their throughput controlled by the bottleneck, and their schedules
should be determined by that of the bottleneck.
EXAMPLE PROBLEM
Suppose a manufacturer makes wagons composed of a box body, a handle assembly,
and two wheel assemblies. Demand for the wagons is 500 a week. The wheel assembly
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capacity is 1200 sets a week, the handle assembly capacity is 450 a week, and final
assembly can produce 550 wagons a week.
a.
b.
c.
d.
e.
What is the capacity of the factory?
What limits the throughput of the factory?
How many wheel assemblies should be made each week?
What is the utilization of the wheel assembly operation?
What happens if the wheel assembly utilization is increased to 100%?
Answer
a. 450 units a week.
b. Throughput is limited by the capacity of the handle assembly operation.
c. 900 wheel assemblies should be made each week. This matches the capacity of
the handle assembly operation.
d. Utilization of the wheel assembly operation is 900 , 1200 = 75%.
e. Excess inventory builds up.
Some bottleneck principles. Since bottlenecks control the throughput of a facility, some important principles should be noted:
1. Utilization of a nonbottleneck resource is not determined by its potential but by
another constraint in the system. In the previous example problem, the utilization of
the wheel assembly operation was determined by the handle assembly operation.
2. Using a nonbottleneck 100% of the time does not produce 100% utilization. If the
wheel assembly operation was utilized 100% of the time, it would produce 1200
sets of wheels a week, 300 sets more than needed. Because of the buildup of
inventory, this operation would eventually have to stop.
3. The capacity of the system depends on the capacity of the bottleneck. If the handle
assembly operation breaks down, the throughput of the factory is reduced.
4. Time saved at a nonbottleneck saves the system nothing. Suppose, in a flash of
brilliance, the industrial engineering department increased the capacity of the
wheel assembly operation to 1500 units a week. This extra capacity could not be
utilized, and nothing would be gained.
5. Capacity and priority must be considered together. Suppose the wagon manufacturer made wagons with two styles of handles. During setup, nothing is produced,
which reduces the capacity of the system. Since handle assembly is the bottleneck,
every setup in this operation reduces the throughput of the system. Ideally, the
company would run one style of handle for six months, then switch over to the
second style. However, customers wanting the second style of handle might not be
willing to wait six months. A compromise is needed whereby runs are as long as
possible but priority (demand) is satisfied.
Production Activity Control
169
6. Loads can, and should, be split. Suppose the handle assembly operation
(the bottleneck) produces one style of handle for two weeks, then switches to
the second style. The batch size is 900 handles. Rather than waiting until the
900 are produced before moving them to the final assembly area, the manufacturer can move a day’s production (90) at a time. The process batch size and the
transfer batch size are different. Thus, delivery to the final assembly is matched
to usage, and work-in-process inventory is reduced.
7. Focus should be on balancing the flow through the shop. The key is throughput
that ends up in sales
Managing bottlenecks. Since bottlenecks are so important to the throughput of
a system, scheduling and controlling them is extremely important. The following must
be done:
1. Establish a time buffer before each bottleneck. A time buffer is an inventory (queue)
place before each bottleneck. Because it is of the utmost importance to keep the
bottleneck working, it must never be starved for material, and it can be starved
only if the flow from feeding workstations is disrupted. The time buffer should be
only as long as the time of any expected delay caused by feeding workstations. In
this way, the time buffer ensures that the bottleneck will not be shut down for lack
of work and this queue will be held at a predetermined minimum quantity.
2. Control the rate of material feeding the bottleneck. A bottleneck must be fed at a
rate equal to its capacity so the time buffer remains constant. The first operation in the sequence of operations is called a gateway operation. This operation
controls the work feeding the bottleneck and must operate at a rate equal to the
output of the bottleneck so the time buffer queue is maintained.
3. Do everything to provide the needed bottleneck capacity. Anything that increases
the capacity of the bottleneck increases the capacity of the system. Better utilization, fewer setups, and improved methods to reduce setup and run time are
some methods for increasing capacity.
4. Adjust loads. This is similar to item 3 but puts emphasis on reducing the load on
a bottleneck by using such things as alternate work centers and subcontracting.
These may be more costly than using the bottleneck, but utilization of nonbottlenecks and throughput of the total system are increased, resulting in more
company sales and increased profits.
5. Change the schedule. Do this as a final resort, but it is better to be honest about
delivery promises.
Once the bottleneck is scheduled according to its available capacity and the market demand it must satisfy, the nonbottleneck resources can be scheduled. When a work
order is completed at the bottleneck, it can be scheduled on subsequent operations.
Feeding operations have to protect the time buffer by scheduling backward in time
from the bottleneck. If the time buffer is set at four days, the operation immediately preceding the bottleneck is scheduled to complete the required parts four days before they
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are scheduled to run on the bottleneck. Each preceding operation can be back scheduled
in the same way so the parts are available as required for the next operation.
Any disturbances in the feeding operations are absorbed by the time buffer, and
throughput is not affected. Also, work-in-process inventory is reduced. Since the
queue is limited to the time buffer, lead times are reduced.
THEORY OF CONSTRAINTS AND DRUM-BUFFER-ROPE
The section of “Scheduling Bottlenecks” was developed by Eliyahu M. Goldratt in his
Theory of Constraints. It has allowed many people to rethink their approaches to
improving and managing their production processes. The fundamental concept
behind the work is that every operation producing a product or service is a series of
linked processes. Each process has a specific capacity to produce the given defined
output for the operation, and in virtually every case, there is one process that limits or
constrains the throughput from the entire operation. Refer to Figure 6.11 for an
example of an operation producing product A.
The total operation is constrained by process 3 at four per hour. No matter how
much efficiency there is in the other processes and how many process improvements
are made in processes 1, 2, and 4, it will never be possible to exceed the overall operational output of four per hour. Increased efficiency and utilization in processes 1
and 2 will only increase inventory—not sales.
Manage the Constraint
Several fundamental guidelines have been developed for understanding how to manage a constraining process or bottleneck. Some of the more noteworthy include
focusing on balancing the flow through the shop, time lost at a bottleneck is time lost
to the whole system but time lost at a nonconstraint is a mirage, and transfer batches
do not have to be the same size as process batches. All of these were discussed in the
section “Some Bottleneck Principles.”
Improve the Process
Once a constraint has been identified, there is a five-step process that is recommended to help improve the performance of the operation. The five steps are summarized as follows:
1. Identify the constraint. This implies the need to examine the entire process to
determine which process limits the throughput. The concept does not limit this
PROCESS 1
Capacity =
5 per hour
Figure 6.11 Process A.
PROCESS 2
Capacity =
7 per hour
PROCESS 3
Capacity =
4 per hour
PROCESS 4
Capacity =
9 per hour
Production Activity Control
2.
3.
4.
5.
171
process examination to merely the operational processes. For example, in
Figure 6.11, suppose the sales department was only selling the output at the rate
of three per hour. In that case, sales would be the constraint and not process 3.
It must be remembered that a constraint limits throughput, not inventory or
production.
Exploit the constraint. Find methods to maximize the utilization of the constraint
toward productive throughput. For example, in many operations all processes
are shut down during lunchtime. If a process is a constraint, the operation should
consider rotating lunch periods so that the constraint is never allowed to be idle.
Subordinate everything to the constraint. Effective utilization of the constraint is
the most important issue. Everything else is secondary.
Elevate the constraint. This means to find ways to increase the available hours of
the constraint, including more of it.
Once the constraint is a constraint no longer, find the new one and repeat the steps.
As the effective utilization of the constraint increases, it may cease to be a constraint as another process becomes one. In that case the emphasis shifts to the
new process constraint.
Scheduling with the Theory of Constraints
Even the scheduling system developed for the Theory of Constraints has its own specific approach. It is often described as Drum-Buffer-Rope:
• Drum. The drum of the system refers to the “drumbeat” or pace of production.
It represents the master schedule for the operation, which is focused around the
pace of throughput as defined by the constraint.
• Buffer. Since it is so important that the constraint never be “starved” for needed
inventory, a “time” buffer is often established in front of the constraint. It is
called a time buffer because it represents the amount of time that the inventory
in the buffer protects the constraint from disruptions.
• Rope. The analogy is that the rope “pulls” production to the constraint for necessary processing. Although this may imply a reactive replenishment system,
such as a reorder point, it can be done by a well-coordinated release of material
into the system at the right time.
Even the scheduling system has its primary focus on effective management of
the organization’s constraint to throughput and sales.
Four primary plant types are defined, and they are used to specify the flow of
materials through a production process. They can therefore be helpful in understanding how to manage the operation using the Theory of Constraints. They include:
• I-plant, where processing is done in a straight line, such as may be in an assembly line.
• A-plant, where numerous subassemblies merge into a single final assembly.
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Chapter 6
• V-plant, where few raw materials can be made into several end products.
• T-plant, where multiple straight lines can split into several assemblies.
The Theory of Constraints also includes a process to help develop and implement change in an organization. The first step to this is to identify core conflicts,
which are then validated by building what is called a current reality tree. After those
undesirable effects are identified from the core conflicts, the next step is to develop a
future reality tree, which will lay out a strategy to resolve the problems. The final
major step in the process is to build a tactical objective map that will define a strategy
to accomplish the future reality.
EXAMPLE PROBLEM
Parent X requires 1 each of component Y and Z. Both Y and Z are processed on
work center 20 which has an available capacity of 40 hours. The setup time for component Y is 1 hour and the run time 0.3 hour per piece. For component Z, setup time
is 2 hours and the run time is 0.20 hour per piece. Calculate the number of Ys and Zs
that can be produced.
Answer
Available capacity for Ys and Zs = 40 hours
Let x = number of Ys and Zs to produce
TimeY + TimeZ = 40 hours
1 + 0.3x + 2 + 0.2x = 40 hours
0.5x = 37 hours
x = 74
Therefore, work center 20 can produce 74 Ys and 74 Zs.
IMPLEMENTATION
Orders that have tooling, material, and capacity have a good chance of being completed on time and can be released to the shop floor. Other orders that do not have
all of the necessary elements should not be released because they only cause excess
work-in-process inventory and may interrupt work on orders that can be completed.
The process for releasing an order is shown in Figure 6.12.
Implementation is arrived at by issuing a shop order to manufacturing authorizing them to proceed with making the item. A shop packet is usually compiled and
contains the shop order and whatever other information is needed by manufacturing.
It may include any of the following:
• Shop order showing the shop order number, part number, name, description,
and quantity.
• Engineering drawings.
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Production Activity Control
• Bills of material.
• Route sheets showing the operations to be performed, equipment and accessories needed, materials to use, and setup and run times.
• Material issue tickets that authorize manufacturing to get the required material
from stores. These are also used for charging the material against the shop
order.
• Tool requisitions authorizing manufacturing to withdraw necessary tooling from
the tool crib.
• Job tickets for each operation to be performed. As well as authorizing the individual operations to be performed, they also can function as part of a reporting
system. The worker can log on and off the job using the job ticket, and it then
becomes a record of that operation.
• Move tickets that authorize and direct the movement of work between operations.
Figure 6.12 Order release
process.
REVIEW
ORDER
CHECK TOOLING
AND MATERIAL
AVAILABILITY
OKAY?
No
RESOLVE
Yes
CHECK CAPACITY
REQUIREMENTS
AND AVAILABILITY
(SCHEDULE AND
LOAD)
OKAY?
Yes
RELEASE
ORDER
No
RESOLVE
OR
RESCHEDULE
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Chapter 6
CONTROL
Once work orders have been issued to manufacturing, their progress has to be controlled. To control progress, performance has to be measured and compared to what
is planned. If what is actually happening (what is measured) varies significantly from
what was planned, either the plans have to be changed or corrective action must be
taken to bring performance back to plan.
The objectives of production activity control are to meet delivery dates and to
make the best use of company resources. To meet delivery dates, a company must
control the progress of orders on the shop floor, which means controlling the lead
time for orders. As discussed previously in this chapter, the largest component of lead
time is queue. If queue can be controlled, delivery dates can be met. Chapter 1
discussed some characteristics of intermittent operations in which many different
products and order quantities have many different routings, each requiring different
capacities. In this environment, it is almost impossible to balance the load over all the
workstations. Queue exists because of this erratic input and output.
To control queue and meet delivery commitments, production activity control must:
• Control the work going into and coming out of a work center. This is generally
called input/output control.
• Set the correct priority of orders to run at each work center.
Input/Output Control
Production activity control must balance the flow of work to and from different work centers. This is to ensure queue, work-in-process, and lead times are controlled. The
input/output control system is a method of managing queues and work-in-process lead
times by monitoring and controlling the input to, and output from, a facility. It is designed
to balance the input rate in hours with the output rate so these will be controlled.
The input rate is controlled by the release of orders to the shop floor. If the rate
of input is increased, queue, work-in-process, and lead times increase. The output
rate is controlled by increasing or decreasing the capacity of a work center. Capacity
change is a problem for manufacturing, but it can be attained by overtime or undertime, shifting workers, and so forth. Figure 6.13 shows the idea graphically.
Input/output report. To control input and output, a plan must be devised, along
with a method for comparing what actually occurs against what was planned. This
information is shown on an input/output report. Figure 6.14 is an example of such a
report. The values are in standard hours.
Cumulative variance is the difference between the total planned for a given
period and the actual total for that period. It is calculated as follows:
Cumulative variance = previous cumulative variance + actual - planned
Cumulative input variance week 2 = -4 + 32 - 32 = - 4
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Production Activity Control
Input Rate
Control
Queue
(Load, WIP)
Output Rate
Control
Figure 6.13 Input/output control.
Work Center: 201
Capacity per Period: 40 standard hours
Period
1
2
3
4
5
Total
Planned Input
38
32
36
40
44
190
Actual Input
34
32
32
42
40
180
Cumulative Variance
–4
–4
–8
–6
–10
–10
Planned Output
40
40
40
40
40
200
Actual Output
32
36
44
44
36
192
Cumulative Variance
–8
–12
–8
–4
–8
–8
Planned Backlog
32
30
22
18
18
22
Actual Backlog
32
34
30
18
16
20
Figure 6.14 Input/output report.
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Chapter 6
Backlog is the same as queue and expresses the work to be done in hours. It is
calculated as follows:
Planned backlog for period 1 previous backlog planned input planned output
= 32 + 38 - 40
= 30 hours
The report shows the plan was to maintain a level output in each period and to
reduce the queue and lead time by 10 hours, but input and output were lower than
expected.
Planned and actual inputs monitor the flow of work coming to the work center.
Planned and actual outputs monitor the performance of the work center. Planned
and actual backlogs monitor the queue and lead time performance.
EXAMPLE PROBLEM
Complete the following input/output report for weeks 1 and 2.
Week
1
2
Planned Input
45
40
Actual Input
42
46
Planned Output
40
40
Actual Output
42
44
Cumulative Variance
Cumulative Variance
Planned Backlog
30
Actual Backlog
30
Answer
Cumulative input variance week 1 = 42 - 45 = -3
Cumulative input variance week 2 = -3 + 46 - 40 = 3
Cumulative output variance week 1 = 42 - 40 = 2
Cumulative output variance week 2 = 2 + 44 - 40 = 6
Production Activity Control
177
Planned backlog week 1 = 30 + 45 - 40 = 35
Planned backlog week 2 = 35 + 40 - 40 = 35
Actual backlog week 1 = 30 + 42 - 42 = 30
Actual backlog week 2 = 30 + 46 - 44 = 32
Operation Sequencing
The eleventh edition of the APICS Dictionary defines operation sequencing as
“a technique for short-term planning of actual jobs to be run in each work center
based on capacity (i.e., existing workforce and machine availability) and priorities.”
Priority, in this case, is the sequence in which jobs at a work center should be
worked on.
The material requirements plan establishes proper need dates and quantities.
Over time, these dates and quantities change for a variety of reasons. Customers may
require different delivery quantities or dates. Deliveries of component parts, either
from vendors or internally, may not be met. Scrap, shortages, and overages may
occur, and so on. Control of priorities is exercised through dispatching.
Dispatching. Dispatching is the function of selecting and sequencing available jobs
to be run at individual work centers. The dispatch list is the instrument of priority
control. It is a listing by operation of all the jobs available to be run at a work center
with the job listed in priority sequence. It normally includes the following information
and is updated and published at least daily:
• Plant, department, and work center.
• Part number, shop order number, operation number, and operation description
of jobs at the work center.
• Standard hours.
• Priority information.
• Jobs coming to the work center.
Figure 6.15 is an example of a daily dispatch list.
Dispatching rules. The ranking of jobs for the dispatch list is created through the
application of priority rules. There are many rules, some attempting to reduce workin-process inventory, others attempting to minimize the number of late orders or
maximize the output of the work center. None is perfect or will satisfy all objectives.
Some commonly used rules are:
• First come, first served (FCFS). Jobs are performed in the sequence in which
they are received. This rule ignores due dates and processing time.
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Chapter 6
DISPATCH LIST
Work Center: 10
Rated Capacity: 16 standard hours per day
Shop Date: 250
Order
Part
Order
Number Number Quantity
123
121
142
6554
7345
2687
Jobs Coming
145
7745
135
2832
100
50
500
Setup
Run
Hours Hours
75
10
0
3.75
24
75
Total Available Load in Standard Hours
102.75
200
20
1.5
0.5
0.2
0.7
1.2
15
30
75
Total
Quantity
Load
Operation Dates
Hours Completed Remaining
Start Finish
20
1.0
16.5
30.5
75.2
20.7
2.7
0
0
20.7
2.7
Total Future Load in Standard Hours
23.4
249
249
250
250
251
259
251
253
253
254
Figure 6.15 Dispatch list (based on 2 machines working one 8-hour shift per day).
• Earliest job due date (EDD). Jobs are performed according to their due dates.
Due dates are considered, but processing time is not.
• Earliest operation due date (ODD). Jobs are performed according to their operation due dates. Due dates and processing time are taken into account. As well,
the operation due date is easily understood on the shop floor.
• Shortest process time (SPT). Jobs are sequenced according to their process time.
This rule ignores due dates, but it maximizes the number of jobs processed.
Orders with long process times tend to be delayed.
Figure 6.16 illustrates how these sequencing rules work. Notice that each rule
usually produces a different sequence.
One other rule that should be mentioned is called critical ratio (CR). This is an
index of the relative priority of an order to other orders at a work center. It is based
on the ratio of time remaining to work remaining and is usually expressed as:
CR =
due date - present date
actual time remaining
=
lead time remaining
lead time remaining
Lead time remaining includes all elements of manufacturing lead time and
expresses the amount of time the job normally takes to completion.
If the actual time remaining is less than the lead time remaining, it implies there
is not sufficient time to complete the job and the job is behind schedule. Similarly, if
lead time remaining and actual time remaining are the same, the job is on schedule.
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Production Activity Control
Sequencing Rule
Job
Process
Arrival
Time (days) Date
Due
Date
Operation
Due Date
FCFS
EDD
ODD
SPT
A
4
223
245
233
2
4
1
3
B
1
224
242
239
3
2
2
1
C
5
231
240
240
4
1
3
4
D
2
219
243
242
1
3
4
2
Figure 6.16 Application of sequencing rules.
If the actual time remaining is greater than the lead time remaining, the job is ahead
of schedule. If the actual time remaining is less than 1, the job is late already. The following table summarizes these facts and relates them to the critical ratio:
CR less than 1 (actual time less than lead time).
CR equal to 1 (actual time equal to lead time).
CR greater than 1 (actual time greater than lead time).
CR zero or less (today’s date greater than due date).
Order is behind schedule.
Order is on schedule.
Order is ahead of schedule.
Order is already late.
Thus, orders are listed in order of their critical ratio with the lowest one first.
Critical ratio considers due dates and process time. However, it is not easily
understood.
EXAMPLE PROBLEM
Today’s date is 175. Orders A, B, and C have the following due dates and lead time
remaining. Calculate the actual time remaining and the critical ratio for each.
Order
Due Date
Lead Time
Remaining (days)
A
B
C
185
195
205
20
20
20
Answer
Order A has a due date of 185, and today is day 175. There are 10 actual days remaining. Since the lead time remaining is 20 days,
Critical ratio =
10
= 0.5
20
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Chapter 6
Similarly, the actual time remaining and the critical ratios are calculated for
orders B and C. The following table gives the results:
Order
Due Date
Lead Time
Remaining (days)
Actual Time
Remaining (days)
CR
185
195
205
20
20
20
10
20
30
0.5
1.0
1.5
A
B
C
Order A has less actual time remaining than lead time remaining, so the CR is
less than 1. It is, therefore, behind schedule. Order B has a CR of 1 and is exactly on
schedule. Order C has a CR of 1.5—greater than 1—and is ahead of schedule.
Dispatching rules should be simple to use and easy to understand. As shown in
the preceding example, each rule produces a different sequence and has its own
advantages and disadvantages. Whichever rule is selected should be consistent with
the objectives of the planning system.
PRODUCTION REPORTING
Production reporting provides feedback of what is actually happening on the plant
floor. It allows PAC to maintain valid records of on-hand and on-order balances, job
status, shortages, scrap, material shortages, and so on. Production activity control
needs this information to establish proper priorities and to answer questions regarding deliveries, shortages, and the status of orders. Manufacturing management needs
this information to make decisions about plant operation. Payroll needs this information to calculate employees’ pay.
Data must be collected, sorted, and reported. The particular data collected
depend upon the needs of the various departments. The methods of data collection
vary. Sometimes the operator reports the start and completion of an operation,
order, movement, and so on, using an online system directly reporting events as they
occur via data terminals. In other cases, the operator, supervisor, or timekeeper
reports this information on an operation reporting form included in the shop packet.
Information about inventory withdrawals and receipts must be reported as well.
Once the data are collected, they must be sorted and appropriate reports produced. Types of information needed for the various reports include:
•
•
•
•
•
Order status.
Weekly input/output by department or work center.
Exception reports on such things as scrap, rework, and late shop orders.
Inventory status.
Performance summaries on order status, work center and department efficiencies, and so on.
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Production Activity Control
SUMMARY
Production activity control is concerned with converting the material requirements
plan into action, reporting the results achieved, and when required, revising the plans
and actions to meet the required results. Order release, dispatching, and progress
reporting are the three primary functions. To accomplish the plans, PAC must establish detailed schedules for each order, set priorities for work to be done at each work
center, and keep them current. Production activity control is also responsible for
managing the queue and lead times. The Theory of Constraints (TOC) modifies the
approach to PAC since it views a production facility, the suppliers, and the market as
a series of interdependent functions. TOC attempts to optimize the constraints (bottlenecks) in a system as they affect the overall throughput of the system. As a result,
traditional lot sizing rules should be modified to increase the throughput of the entire
system and not just the individual work centers. Drum-buffer-rope describes how the
TOC works by setting an overall pace of material flow, ensuring bottlenecks never
run out of material and linking the output of one work center to another. If PAC is
performing its functions, the company should be able to meet delivery dates, utilize
labor and equipment efficiently, and keep inventory levels down.
KEY TERMS
Flow manufacturing 156
Repetitive manufacturing
156
Continuous manufacturing
156
Intermittent manufacturing
156
Project manufacturing 157
Item master file 157
Product structure file (bill of
material file) 157
Routing file 158
Work center master file 158
Shop order master file 158
Shop order detail file 159
Manufacturing lead time 160
Cycle time 160
Throughput time 160
Forward scheduling 161
Backward scheduling 161
Infinite loading 162
Finite loading 162
Operation overlapping 164
Operation splitting 165
Bottlenecks 167
Throughput 167
Gateway operation 169
Drum-Buffer-Rope 171
Input/output control 174
Input/output report 174
Cumulative variance 174
Dispatching 177
Critical ratio (CR) 178
QUESTIONS
1. What is the responsibility of production activity control?
2. What are the major functions of planning, implementation, and control?
3. What are the major characteristics of flow, intermittent, and project manufacturing?
4. Why is production activity control more complex in intermittent manufacturing?
5. To plan the flow of materials through manufacturing, what four things must production
activity control know? Where will information on each be obtained?
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Chapter 6
6. What are the four planning files used in production activity control? What information
does each contain?
7. What are the two control files? What are their purposes?
8. What should production activity control check before releasing a shop order?
9. What is manufacturing lead time? Name and describe each of its elements.
10. Describe forward and backward scheduling. Why is backward scheduling preferred?
11. Describe infinite and finite loading.
12. What is operation overlapping? What is its purpose?
13. What is operation splitting? What is its purpose?
14. What information does a load report contain? Why is it useful to production activity control?
15. What is a bottleneck operation?
16. What is the definition of throughput?
17. What are the six bottleneck principles discussed in the text?
18. What are the five things discussed in the text that are important in managing bottlenecks?
19. What is a shop order? What kind of information does it usually contain?
20. What two things must be done to control queue and meet delivery commitments?
21. What is an input/output control system designed to do? How is input controlled? How is
output controlled?
22. What is dispatching? What is a dispatch list?
23. Describe each of the following dispatching rules giving their advantages and disadvantages.
a. First come, first served.
b. Earliest due date.
c. Earliest operation due date.
d. Shortest processing time.
e. Critical ratio.
24. If the time remaining to complete a job is 10 days and the lead time remaining is 12 days,
what is the critical ratio? Is the order ahead of schedule, on schedule, or behind schedule?
25. What is the purpose of production reporting? Why is it needed?
26. A student of production inventory management has decided to apply critical ratio to his
homework assignments. Describe what is happening if his critical ratio for various
assignments is:
a. negative.
b. zero.
c. between zero and 1.
d. greater than 1.
27. Bottlenecks exist in many business processes that serve the public and are usually indicated by lineups. Choose a business that experiences lineups and identify the constraints
in the system. Give specific examples of each of the seven bottleneck principles that
apply to that business. Suggest a way to increase the throughput of the bottleneck and
describe the benefits to the business and to the customers.
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Production Activity Control
PROBLEMS
6.1
Shop order 7777 is for 600 of part 8900. From the routing file, it is found that operation
20 is done on work center 300. The setup time is 3.5 hours, and run time is 0.233 hours
per piece. What is the required capacity on work center 300 for shop order 7777?
6.2
An order for 100 of a product is processed on work centers A and B. The setup time on
A is 50 minutes, and run time is 5 minutes per piece. The setup time on B is 60 minutes,
and the run time is 5 minutes per piece. Wait time between the two operations is 5 hours.
The move time between A and B is 40 minutes. Wait time after operation B is 5 hours,
and the move time into stores is 3 hours. Queue at work center A is 25 hours and at B is
35 hours. Calculate the total manufacturing lead time for the order.
Answer.
143.3 standard hours
Answer.
6.3
92 hours and 10 minutes
In problem 6.2, what percent of the time is the order actually running?
Answer.
18.08%
6.4
An order for 50 of a product is processed on work centers A and B. The setup time on A
is 60 minutes, and run time is 5 minutes per piece. The setup time on B is 30 minutes,
and the run time is 6 minutes per piece. Wait time between the two operations is 10
hours. The move time between A and B is 60 minutes. Wait time after operation B is 8
hours, and the move time into stores is 2 hours. Queue at work center A is 40 hours and
at B is 35 hours. Calculate the total manufacturing lead time for the order.
6.5
In problem 6.4, what percent of time is the order actually running?
6.6
Amalgamated Skyhooks, Inc., has an order for 200 Model SKY3 Skyhooks for delivery
on day 200. The Skyhook consists of three parts. Components B and C form subassembly
A. Subassembly A and component D form the final assembly. Following are the work
centers and times for each operation. Using a piece of graph paper, draw a backward
schedule based on the following. When must component C be started to meet the delivery date?
a. Only one machine is assigned to each operation.
b. The factory works one 8-hour shift 5 days a week.
c. All parts move in one lot of 200.
Part
D
B
C
Subassembly A
Final Assembly SKY3
Answer.
Day 175
Operation
Standard Time (days)
10
20
10
20
10
20
5
7
5
7
10
5
5
5
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Chapter 6
6.7
International Door Slammers has an order to deliver 500 door slammers on day 130.
Draw up a backward schedule under the following conditions:
a. Only one machine is assigned to each operation.
b. Schedule one 8-hour shift per day for 5 days per week.
c. All parts are to move in one lot of 500 pieces.
d. Allow 8 hours between operations for queue and move times.
A slammer consists of three parts. Purchased components C and D form subassembly
A. Subassembly A and component B form the final assembly. Part B is machined in three
operations. No special tooling is required except for part B, operation 20. It takes 24
hours to make the tooling. Material is available for all parts.
Standard times for the lot of 500 are as follows:
Part
B
Operation
Standard Time (days)
10
20
30
10
6
6
16
10
Subassembly A
Final Assembly
6.8 An order for 100 of a product is processed on operation A and operation B. The setup
time on A is 50 minutes, and the run time per piece is 9 minutes. The setup time on B is
30 minutes, and the run time is 6 minutes per piece. It takes 20 minutes to move a lot
between A and B. Since this is a rush order, it is given top priority (president’s edict) and
is run as soon as it arrives at either workstation.
It is decided to overlap the two operations and to split the lot of 100 into two lots of
60 and 40. When the first lot is finished on operation A, it is moved to operation B where
it is set up and run. Meanwhile, operation A completes the balance of the 100 units (40)
and sends the units over to operation B. These 40 units should arrive as operation B is
completing the first batch of 60; thus, operation B can continue without interruption
until all 100 are completed.
a. Calculate the total manufacturing lead time for operation A and for B without
overlapping.
b. Calculate the manufacturing lead time if the operations are overlapped. How much
time is saved?
Answer.
a. Total manufacturing lead time = 1600 minutes
b. Total manufacturing lead time = 1240 minutes
Saving in lead time = 360 minutes
6.9 An order for 200 bell ringers is processed on work centers 10 and 20. The setup and run
times are as follows. It is decided to overlap the lot on the two work centers and to split
the lot into two lots of 75 and 125. Move time between operations is 30 minutes. Work
center 20 cannot be set up until the first lot arrives. Calculate the saving in manufacturing lead time.
Setup on A = 50 minutes
Setup on B = 100 minutes
Run time on A = 5 minutes per piece
Run time on B = 7 minutes per piece
Production Activity Control
185
6.10 An order for 100 of a product is processed on operation A. The setup time is 50 minutes,
and the run time per piece is 9 minutes. Since this is a rush order, it is to be split into two
lots of 50 each and run on two machines in the work center. The machines can be set up
simultaneously.
a. Calculate the manufacturing lead time if the 100 units are run on one machine.
b. Calculate the manufacturing lead time when run on two machines simultaneously.
c. Calculate the reduction in lead time.
Answer.
a. 950 minutes
b. 500 minutes
c. 450 minutes
6.11 What would be the reduction in MLT if the second machine could not be set up until the
setup was completed on the first machine?
6.12 An order for 100 of a product is run on work center 40. The setup time is 4 hours, and
the run time is 3 minutes per piece. Since the order is a rush and there are two machines
in the work center, it is decided to split the order and run it on both machines. Calculate
the manufacturing lead time before and after splitting.
6.13 In problem 6.12, what would be the manufacturing lead time if the second machine
could not be set up until the setup on the first machine was completed? Would there be
any reduction in manufacturing lead time?
6.14 Bill builds benches in a small shop and he plans to operate five 8-hour days per week.
Each bench has two ends and a top. It takes 5 minutes to cut and sand each end and 3
minutes to make each top. Assembly requires 10 minutes per bench, and painting
requires 5 minutes per bench. Bill has one employee who makes the tops and ends. Bill
will do the final assembly and painting. He also plans 1 hour per day for setup and teardown for each department.
a. How many benches should he plan to build per week?
b. How many hours per week are required for each person?
c. Suggest ways to increase the number of benches produced per week.
6.15 Parent W requires one of component B and two of component C. Both B and C are
run on work center 10. Setup time for B is 2 hours, and run time is 0.1 hour per piece.
For component C, setup time is 2 hours, and run time is 0.15 hour per piece. If the
rated capacity of the work center is 80 hours, how many Ws should be produced in a
week?
Answer.
190 Ws
6.16 Parent S requires three of component T and two of component U. Both T and U are run
on work center 30. Setup time for T is 7 hours, and run time is 0.1 hour per piece. For
component U, setup time is 8 hours, and run time is 0.2 hour per piece. If the rated
capacity of the work center is 120 hours, how many Ts and Us should be produced in a
week?
Answer.
450 T’s and 300 U’s a week
6.17 Complete the following input/output report. What are the planned and actual backlogs
at the end of period 4?
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Period
1
2
3
4
Planned Input
35
37
36
41
Actual Input
33
33
31
43
Planned Output
40
40
40
40
Actual Output
39
35
40
38
Total
Cumulative Variance
Cumulative Variance
Planned Backlog
32
Actual Backlog
32
Answer.
Planned backlog = 21 units. Actual backlog = 20 units.
6.18 Complete the following input/output report. What is the actual backlog at the end of
period 5?
Period
1
2
3
4
5
Planned Input
78
78
78
78
78
Actual Input
82
80
74
82
84
Planned Output
80
80
80
80
80
Actual Output
87
83
74
80
84
Cumulative Variance
Cumulative Variance
Total
187
Production Activity Control
Planned Backlog
45
Actual Backlog
45
Answer.
39 units
6.19 Complete the following table to determine the run sequence for each of the sequencing rules.
Sequencing Rule
Process
Arrival
Time (days) Date
Job
Due
Date
Operation
Due Date
A
5
123
142
132
B
2
124
144
131
C
3
131
140
129
FCFS
EDD
ODD
SPT
6.20 Jobs X, Y, and Z are in queue at work center 10 before being completed on work center
20. The following information pertains to the jobs and the work centers. For this problem, there is no move time. Today is day 1. If the jobs are scheduled by the earliest due
date, can they be completed on time?
Job
Process Time (days)
Due Date
Work Center 10
Work Center 20
A
7
3
12
B
5
2
24
C
9
4
18
Job
Work Center 10
Start Day
A
C
B
Stop Day
Work Center 20
Start Day
Stop Day
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6.21 Calculate the critical ratios for the following orders and establish in what order they
should be run. Today’s date is 75.
Order
Due Date
Lead Time
Remaining (days)
A
B
C
87
95
100
12
26
21
Actual Time
Remaining (days)
CR
Production Activity Control
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JOHNSTON PRODUCTS
No matter how many times Justin Wang, the master scheduler for Johnston Products,
tried, he couldn’t seem to get it through people’s minds. They kept trying to “front
load” the production schedule, and the problem appeared to be getting worse.
By “front loading” Justin meant that production supervisors would attempt to
catch up with production they failed to make the previous week. It seemed to happen
every week, and the only way Justin could get things back to a realistic position was to
completely reconstruct the entire master schedule—usually about every three weeks.
Last month could serve as an example. The first week of the month Justin had
scheduled production equal to 320 standard hours in the assembly area. The assembly area managed to complete only 291 hours that week because of some equipment
maintenance and a few unexpected part shortages. The assembly supervisor then had
the workers complete the remaining 29 hours from week 1 at the start of week 2.
Since week 2 already had 330 standard hours scheduled, the additional 29 hours
really put them in a position of attempting to complete 359 hours. The workers actually completed 302 hours in week 2, leaving 57 hours to front load into week 3, and so
forth. Usually by the time Justin came to his three-week review of the master schedule, it was not uncommon for the assembly area to be more than 100 standard hours
behind schedule.
Clearly something needed to be done. Justin decided to review some of the
areas that could be causing the problem:
1. Job standards—Although it had been at least four years since any job standards had
been reviewed or changed, Jason felt the standards could not be the problem—
quite the opposite. His operations course had taught him about the concept of
the learning curve, implying that if anything the standards should be too large,
allowing the average worker to complete even more production than implied by
the job standard.
2. Utilization—The general manager was very insistent on high utilization of the
area. He felt that it would help control costs, and consequently used utilization
as a major performance measure for the assembly area. The problem was that
customer service was also extremely important. With the problems Justin was
having with the master schedule, it was difficult to promise order delivery accurately, and equally difficult to deliver the product on time once the order
promise was made.
3. The workers—In an effort to control costs, the hourly wage for the workers was
not very high. This caused a turnover in the workforce of almost 70% per year.
In spite of this, the facility was located in an area where replacement workers
were fairly easy to hire. They were assigned to the production area after they
had a minimum of one week’s worth of training on the equipment. In the meantime, the company filled vacant positions with temporary workers brought in by
a local temporary employment service.
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4. Engineering changes—The design of virtually all the products was changing, with
the average product changing some aspect of the design about every two months.
Usually this resulted in an improvement to the products, however, so Justin
quickly dismissed the changes as a problem. There were also some engineering
changes on the equipment, but in general little in the way of process change had
been made. The setup time for a batch of a specific design had remained at
about 15 minutes. That forced a batch size of about from 50 to 300 units,
depending on the design. The equipment was getting rather old, however, forcing regular maintenance as well as causing an occasional breakdown. Each piece
of equipment generally required about three hours of maintenance per week.
Since the computer had done most of his calculations in the past, Justin decided to
check to see if the computer was the source of the problem. He gathered information
to conduct a manual calculation on a week when there were eight people assigned to
the assembly area (one person for each of eight machines) for one shift per day. With
no overtime, that would allow 320 hours of production.
Product
A174
G820
H221
B327
C803
P932
F732
J513
L683
Batch Size
Standard Assembly Time
(minutes per item)
50
100
50
200
100
300
200
150
150
17
9
19.5
11.7
21.2
14.1
15.8
17.3
12.8
Case Analysis
1. With this information, Justin calculated the total standard time required to be within the
320 hours available. Is he correct? Calculate the time required and check the accuracy of
his calculation.
2. List the areas you think are causing trouble in this facility.
3. Develop a plan to deal with the situation and try to get the production schedule back
under control under the constraints listed.
7
Purchasing
INTRODUCTION
Purchasing is the “process of buying.” Many assume purchasing is solely the responsibility of the purchasing department. However, the function is much broader and, if it
is carried out effectively, all departments in the company are involved. Obtaining the
right material, in the right quantities, with the right delivery (time and place), from
the right source, and at the right price are all purchasing functions.
Choosing the right material requires input from the marketing, engineering,
manufacturing, and purchasing departments. Quantities and delivery of finished
goods are established by the needs of the marketplace. However, manufacturing
planning and control (MPC) must decide when to order which raw materials so that
marketplace demands can be satisfied. Purchasing is then responsible for placing the
orders and for ensuring that the goods arrive on time.
The purchasing department has the major responsibility for locating suitable
sources of supply and for negotiating prices. Input from other departments is required
in finding and evaluating sources of supply and to help the purchasing department in
price negotiation. Purchasing, in its broad sense, is everyone’s business.
Purchasing and Profit Leverage
On the average, manufacturing firms spend about 50% of their sales dollars in
the purchase of raw materials, components, and supplies. This gives the purchasing
function tremendous potential to increase profits. As a simple example, suppose
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a firm spends 50% of its revenue on purchased goods and shows a net profit
before taxes of 10%. For every $100 of sales, it receives $10 of profit and spends $50
on purchases. Other expenses are $40. For the moment, assume that all costs
vary with sales. These figures are shown in the following as a simplified income
statement:
INCOME STATEMENT
Sales
Cost of Goods Sold
Purchases
$50
Other Expenses
40
Profit Before Tax
$100
90
$10
To increase profits by $1, a 10% increase in profits, sales must be increased to
$110. Purchases and other expenses increase to $55 and $44. The following modified
income statement shows these figures:
INCOME STATEMENT (SALES INCREASE)
Sales
$110
Cost of Goods Sold
Purchases
$55
Other Expenses
44
99
Profit Before Tax
$11
However, if the firm can reduce the cost of purchases from $50 to $49, a 2%
reduction, it would gain the same 10% increase in profits. In this particular example,
a 2% reduction in purchase cost has the same impact on profit as a 10% increase in
sales.
INCOME STATEMENT (REDUCED PURCHASE COST)
Sales
$100
Cost of Goods Sold
Purchases
$49
Other Expenses
40
89
Profit Before Tax
$11
Purchasing Objectives
Purchasing is responsible for establishing the flow of materials into the firm, following up with the supplier, and expediting delivery. Missed deliveries can create havoc
for manufacturing and sales, but purchasing can reduce problems for both areas,
further adding to the profit.
The objectives of purchasing can be divided into four categories:
• Obtaining goods and services of the required quantity and quality.
• Obtaining goods and services at the lowest cost.
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193
• Ensuring the best possible service and prompt delivery by the supplier.
• Developing and maintaining good supplier relations and developing potential
suppliers.
To satisfy these objectives, some basic functions must be performed:
• Determining purchasing specifications: right quality, right quantity, and right
delivery (time and place).
• Selecting supplier (right source).
• Negotiating terms and conditions of purchase (right price).
• Issuing and administration of purchase orders.
Purchasing Cycle
The purchasing cycle consists of the following steps:
1. Receiving and analyzing purchase requisitions.
2. Selecting suppliers. Finding potential suppliers, issuing requests for quotations,
receiving and analyzing quotations, and selecting the right supplier.
3. Determining the right price.
4. Issuing purchase orders.
5. Following up to ensure delivery dates are met.
6. Receiving and accepting goods.
7. Approving supplier’s invoice for payment.
Receiving and analyzing purchase requisition. Purchase requisitions start
with the department or person who will be the ultimate user. In the material requirements planning environment, the planner releases a planned order authorizing the
purchasing department to go ahead and process a purchase order. At a minimum, the
purchase requisition contains the following information:
•
•
•
•
•
Identity of originator, signed approval, and account to which cost is assigned.
Material specification.
Quantity and unit of measure.
Required delivery date and place.
Any other supplemental information needed.
Electronic requisition systems are now widely used and are often part of enterprise resource planning (ERP) software. The minimum requisition information is still
required, and the system can supply much of the details and control of the information. For example, the requisitioner can enter the desired part number and the system
database will provide the appropriate description, specification, suggested vendors,
shipping instructions, and so on. The system will then forward the requisition for the
appropriate approvals with controls in place for account number and spending limits.
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Once all the approvals have been completed, the requisition is sent to the purchasing
department to produce the purchase order without reentering all the information. For
items of small value (‘c’ items covered in Chapter 9) that are ordered frequently, the
system may send an electronic release of material directly to the approved supplier. The
benefits to the company are ease of entry for the requisitioner, reduced paperwork,
decreased turnaround time of requisitions, and improved accuracy of information.
Selecting suppliers. Identifying and selecting suppliers are important responsibilities of the purchasing department. For routine items or those that have not been
purchased before, a list of approved suppliers is kept. If the item has not been purchased before or there is no acceptable supplier on file, a search must be made. If the
order is of small value or for standard items, a supplier can probably be found on the
Internet, in a catalogue, trade journal, or directory.
Requesting quotations. For major items, it is usually desirable to issue a request
for quotation. This is a written inquiry that is sent to enough suppliers to be sure competitive and reliable quotations are received. It is not a sales order. After the suppliers
have completed and returned the quotations to the buyer, the quotations are analyzed for price, compliance to specification, terms and conditions of sale, delivery,
and payment terms. For items where specifications can be accurately written, the
choice is probably made on price, delivery, and terms of sale. For items where specifications cannot be accurately written, the items quoted will vary. The quotations
must be evaluated for technical suitability. The final choice is a compromise between
technical factors and price. Usually both the issuing and purchasing departments are
involved in the decision.
Determining the right price. This is the responsibility of the purchasing department and is closely tied to the selection of suppliers. The purchasing department is
also responsible for price negotiation and will try to obtain the best price from the
supplier. Price negotiation will be discussed in a later section of this chapter.
Issuing a purchase order. A purchase order is a legal offer to purchase. Once
accepted by the supplier, it becomes a legal contract for delivery of the goods according to the terms and conditions specified in the purchase agreement. The purchase
order is prepared from the purchase requisition or the quotations and from any other
additional information needed. A copy is sent to the supplier; copies are retained by
purchasing and are also sent to other departments such as accounting, the originating
department, and receiving.
Following up and delivery. The supplier is responsible for delivering the items
ordered on time. The purchasing department is responsible for ensuring that
suppliers do deliver on time. If there is doubt that delivery dates can be met, purchasing must find out in time to take corrective action. This might involve expediting
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transportation, alternate sources of supply, working with the supplier to solve its
problems, or rescheduling production.
The purchasing department is also responsible for working with the supplier on
any changes in delivery requirements. Demand for items changes with time, and it
may be necessary to expedite certain items or push delivery back on some others. The
buyer must keep the supplier informed of the true requirements so that the supplier
is able to provide what is wanted when it is wanted.
Receiving and accepting goods. When the goods are received, the receiving
department inspects the goods to be sure the correct ones have been sent, are in the
right quantity, and have not been damaged in transit. Using its copy of the purchase
order and the bill of lading supplied by the carrier, the receiving department then
accepts the goods and writes up a receiving report noting any variance. If further
inspection is required, such as by quality control, the goods are sent to quality control
or held in receiving for inspection. If the goods are received damaged, the receiving
department will advise the purchasing department and hold the goods for further
action. Provided the goods are in order and require no further inspection, they will be
sent to the originating department or to inventory.
A copy of the receiving report is then sent to the purchasing department noting
any variance or discrepancy from the purchase order. If the order is considered complete, the receiving department closes out its copy of the purchase order and advises
the purchasing department. If it is not, the purchase order is held open awaiting
completion. If the goods have also been inspected by the quality control department,
they, too, will advise the purchasing department whether the goods have been
accepted or not.
Approving supplier’s invoice for payment. When the supplier’s invoice is
received, there are three pieces of information that should agree: the purchase order,
the receiving report, and the invoice. The items and the quantities should be the same
on all; the prices, and extensions to prices, should be the same on the purchase order
and the invoice. All discounts and terms of the original purchase order must
be checked against the invoice. It is the job of the purchasing department to verify
these and to resolve any differences. Once approved, the invoice is sent to accounts
payable for payment.
ESTABLISHING SPECIFICATIONS
The first concern of purchasing—what to buy—is not necessarily a simple decision.
For example, someone deciding to buy a car should consider how the car will be used,
how often, how much one is willing to pay, and so on. Only then can an individual
specify the type of car needed to make the “best buy.” This section looks at the problems that organizations face when developing specifications of products and the types
of specifications that may be used.
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In purchasing an item or a service from a supplier, several factors are included
in the package bought. These must be considered when specifications are being
developed and can be divided into three broad categories:
• Quantity requirements.
• Price requirements.
• Functional requirements.
Quantity Requirements
Market demand first determines the quantity needed. The quantity is important
because it will be a factor in the way the product is designed, specified, and manufactured. For example, if the demand was for only one item, it would be designed to be
made at least cost, or a suitable standard item would be selected. However, if the
demand were for several thousand, the item would be designed to take advantage of
economies of scale, thus satisfying the functional needs at a better price.
Price Requirements
The price specification represents the economic value that the buyer puts on the item—
the amount the individual is willing to pay. If the item is to be sold at a low price, the manufacturer will not want to pay a high price for a component part. The economic value
placed on the item must relate to the use of the item and its anticipated selling price.
Functional Requirements
Functional specifications are concerned with the end use of the item and what the
item is expected to do. By their very nature, functional specifications are the most
important of all categories and govern the others.
In a sense, functional specifications are the most difficult to define. To be successful, they must satisfy the real need or purpose of an item. In many cases, the real
need has both practical and aesthetic elements to it. A coat is meant to keep one
warm, but under what circumstances does it do so and what other functions is it
expected to perform? How cold must it get before one needs a coat? On what occasions will it be worn? Is it for working or dress wear? What color and style should it be?
What emotional needs is it expected to fill? In the same way, we can ask what practical
and aesthetic needs a door handle or side-view mirror on a car is expected to satisfy.
Functional specifications and quality. Functional specifications are intimately
tied to the quality of a product or service. Everyone knows, or thinks he or she knows,
what quality is, but there are several misconceptions about what it is and what it
is not. Ask someone what is meant by quality, and you will get replies such as “The
best there is,” “Perfection,” “Degree of excellence,” and “Very good.” All sound great
but do not mean very much.
There are many definitions of quality, but they all center on the idea of user
satisfaction. On this basis, it can be said that an item has the required quality if it
satisfies the needs of the user.
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197
There are four phases to providing user satisfaction:
1.
2.
3.
4.
Quality and product planning.
Quality and product design.
Quality and manufacturing.
Quality and use.
Product planning is involved with decisions about which products and services a
company is to market. It must decide the market segment to be served, the product
features and quality level expected by that market, the price, and the expected sales
volume. The basic quality level is thus specified by senior managers according to their
understanding of the needs and wants of the marketplace. The success of the product
depends on how well they do this.
The result of the firm’s market studies is a general specification of the product
outlining the expected performance, appearance, price, and sales volume of the product. It is then the job of the product designer to build into the design of the product
the quality level described in the general specification. If this is not properly done, the
product may not be successful in the marketplace.
For manufactured products, it is the responsibility of manufacturing, at a minimum, to meet the specifications laid down by the product designer. If the item is
bought, it is purchasing’s responsibility to make sure the supplier can provide the
required quality level. For purchasing and manufacturing, quality means conforming
to specifications or requirements.
To the final user, quality is related to his or her expectation of how the product
should perform. Customers do not care why a product or service is defective. They
expect satisfaction. If the product is what the customer wants, well designed, well
made, and well serviced, the quality is satisfactory.
Functional specifications should define the quality level needed. They should
describe all those characteristics of a product determined by its final use.
Function, quantity, service, and price are interrelated. It is difficult to specify
one without consideration of the others. Indeed, the final specification is a compromise of them all, and the successful specification is the best combination of the lot.
However, functional specifications ultimately are the ones that drive the others. If the
product does not perform adequately for the price, it will not sell.
Value analysis. Value analysis as defined by the eleventh edition of the APICS
Dictionary is “the systematic use of techniques that identify a required function,
establish a value for that function, and finally provide that function at the lowest
overall cost.” Teams of engineers, users, production personnel and suppliers analyze
parts to challenge current specifications and identify redundant or unnecessary
features. This can reduce the cost and, more importantly, improve the overall functionality of the part. A good example of value analysis is the evolution of the milk
bottle as it went from a heavy glass bottle to a plastic jug. The result is a much
cheaper package with improvements in sterility, transportation, and breakage.
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FUNCTIONAL SPECIFICATION DESCRIPTION
Functional specification can be described in the following ways or by a combination
of them:
1. By brand.
2. By specification of physical and chemical characteristics, material and method
of manufacture, and performance.
3. By engineering drawings.
4. Miscellaneous.
Description by Brand
Description by brand is most often used in wholesale or retail businesses but is also
used extensively in manufacturing. This is particularly true under the following
circumstances:
• Items are patented, or the process is secret.
• The supplier has special expertise that the buyer does not have.
• The quantity bought is so small that it is not worth the buyer’s effort to develop
specifications.
• The supplier, through advertising or direct sales effort, has created a preference
on the part of the buyer’s customers or staff.
When buying by brand, the customer is relying on the reputation and integrity
of the supplier. The assumption is that the supplier wishes to maintain the brand’s
reputation and will maintain and guarantee the quality of the product so repeat purchases will give the buyer the same satisfaction.
Most of the objections to purchasing by brand center on cost. Branded items, as
a group, usually have price levels that are higher than nonbranded items. It may be
less costly to develop specifications for generic products than to rely on brands. The
other major disadvantage to specifying by brand is that it restricts the number of
potential suppliers and reduces competition. Consequently, the usual practice, when
specifying by brand, is to ask for the item by brand name or equivalent. In theory, this
allows for competition.
Description by Specification
There are several ways of describing a product, but they usually include one or more
of the following. Whatever method is used, description by specification depends on
the buyer describing in detail exactly what is wanted:
• Physical and chemical characteristics. The buyer must define the physical and
chemical properties of the materials wanted. Petroleum products, pharmaceuticals, and paints are often specified in this way.
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• Material and method of manufacture. Sometimes the method of manufacture
determines the performance and use of a product. For example, hot- and coldrolled steels are made differently and have different characteristics.
• Performance. This method is used when the buyer is primarily concerned with
what the item is required to do and is prepared to have the supplier decide how
performance is to be attained. For example, a water pump might be specified as
having to deliver so many gallons per minute. Performance specifications are relatively easy to prepare and take advantage of the supplier’s special knowledge.
Whatever the method of specification, there are several characteristics to
description by specification:
• To be useful, specifications must be carefully designed. If they are too loosely
drawn, they may not provide a satisfactory product. If they are too detailed and
elaborate, they are costly to develop, are difficult to inspect, and may discourage possible suppliers.
• Specifications must allow for multiple sources and for competitive bidding.
• If performance specifications are used, the buyer is assured that if the product
does not give the desired results, the seller is responsible. They provide a standard for measuring and checking the materials supplied.
• Not all items lend themselves to specification. For example, it may not be easy
to specify color schemes or the appearance of an item.
• An item described by specification may be no more suitable, and a great deal
more expensive, than a supplier’s standard product.
• If the specifications are set by the buyer, they may be expensive to develop.
They will be used only when there is sufficient volume of purchases to warrant
the cost or where it is not possible to describe what is wanted in any other way.
Sources of specifications. There are two major sources of specifications:
1. Buyer specifications.
2. Standard specifications.
Buyer specifications. Buyer-developed specifications are usually expensive and
time consuming to develop. Companies usually do not use this method unless there is
no suitable standard specification available or unless the volume of work makes it
economical to do so.
Standard specifications. Standard specifications have been developed as a result
of much study and effort by governmental and nongovernmental agencies. They usually apply to raw or semifinished products, component parts, or the composition of
material. In many cases, they have become de facto standards used by consumers and
by industry. When we buy motor oil for a car and ask for SAE 10W30, we are specifying a standard grade of motor oil established by the Society of Automotive Engineers.
Most of the electrical products we buy are manufactured to Underwriters Laboratory
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(UL) standards. Steel and structural steel members are manufactured to standards set
by the American Society of Mechanical Engineers.
There are several advantages to using standard specifications. First, they are
widely known and accepted and, because of this, are readily available from most suppliers. Second, because they are widely accepted, manufactured, and sold, they are
lower in price than nonstandard items. Finally, because they have been developed
with input from a broad range of producers and users, they are usually adaptable to
the needs of many purchasers.
Market grades are a type of standard specification usually set by the government and used for commodities and foodstuffs. When we buy eggs, for example, we
buy them by market grade—small, medium, or large.
Engineering Drawings
Engineering drawings describe in detail the exact configuration of the parts and the
assembly. They also give information on such things as finishes, tolerances, and material to be used. These drawings are a major method of specifying what is wanted and
are widely used because often there is no other way to describe the configuration of
parts or the way they are to fit together. They are produced by the engineering design
department and are expensive to produce, but they give an exact description of the
part required.
Miscellaneous
There are a variety of other methods of specification including the famous phrase
“Gimme one just like the last one.” Sometimes samples are used, for example, when
colors or patterns are to be specified. Often a variety of methods can be used, and the
buyer must select the best one.
The method of description is communication with the supplier. How well it is
done will affect the success of the purchase and sometimes the price paid.
SELECTING SUPPLIERS
The objective of purchasing is to get all the right things together: quality, quantity,
delivery, and price. Once the decision is made about what to buy, the selection of the
right supplier is the next most important purchasing decision. A good supplier is one
that has the technology to make the product to the required quality, has the capacity
to make the quantities needed, and can run the business well enough to make a profit
and still sell a product competitively.
Sourcing
There are three types of sourcing: sole, multiple, and single.
1. Sole sourcing implies that only one supplier is available because of patents,
technical specifications, raw material, location, and so forth.
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2. Multiple sourcing is the use of more than one supplier for an item. The potential
advantages of multiple sourcing are that competition will result in lower price and
better service and that there will be a continuity of supply. In practice there is a
tendency toward an adversarial relationship between supplier and customer.
3. Single sourcing is a planned decision by the organization to select one supplier
for an item when several sources are available. It is intended to produce a longterm partnership. This aspect is discussed at more length in Chapter 15’s
section on supplier partnerships.
Factors in Selecting Suppliers
The previous section discussed the importance of function, quantity, service, and price
specifications. These are what the supplier is expected to provide and are the basis for
selection and evaluation. Considering this, there are several factors in selecting a supplier.
Technical ability. Does the supplier have the technical ability to make or supply
the product wanted? Does the supplier have a program of product development and
improvement? Can the supplier assist in improving the products? These questions
are important since, often, the buyer will depend upon the supplier to provide product improvements that will enhance or reduce the cost of the buyer’s products.
Sometimes the supplier can suggest changes in product specification that will
improve the product and reduce cost.
Manufacturing capability. Manufacturing must be able to meet the specifications for the product consistently while producing as few defects as possible. This
means that the supplier’s manufacturing facilities must be able to supply the quality
and quantity of the products wanted. The supplier must have a good quality assurance program, competent and capable manufacturing personnel, and good manufacturing planning and control systems to ensure timely delivery. These are important in
ensuring that the supplier can supply the quality and quantity wanted.
Reliability. In selecting a supplier, it is desirable to pick one that is reputable,
stable, and financially strong. If the relationship is to continue, there must be an
atmosphere of mutual trust and assurance that the supplier is financially strong
enough to stay in business.
After-sales service. If the product is of a technical nature or likely to need replacement parts or technical support, the supplier must have a good after-sales service. This
should include a good service organization and inventory of service parts.
Supplier location. Sometimes it is desirable that the supplier be located near the
buyer, or at least maintain an inventory locally. A close location helps shorten delivery times and means emergency shortages can be delivered quickly.
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JIT capabilities. Companies competing in a just-in-time (JIT) environment
depend on suppliers to quickly deliver small quantities of product. Modern companies operate with very little inventory of raw materials and require accurate, on-time
deliveries from their suppliers. JIT suppliers who simply keep extra inventory to meet
these demands will soon have increased costs and pressures to increase their prices.
Buyers in a JIT environment need suppliers who value their new relationship, working in partnership to remove waste from the system. As a result, JIT suppliers need to
have in place information and delivery systems that allow them to quickly ship exactly
what the customer needs without increased cost or effort.
Other considerations. Sometimes other factors such as credit terms, reciprocal business, and willingness of the supplier to hold inventory for the buyer should be considered.
Price. The supplier should be able to provide competitive prices. This does not necessarily mean the lowest price. It is one that considers the ability of the supplier to
provide the necessary goods in the quantity and quality wanted, at the time wanted,
as well as any other services needed.
The total acquisition cost of an item includes the price paid plus all the handling
and delivery costs associated with getting the product to production. A buyer will
often get a price and per unit transportation discount by ordering in larger quantities.
However, the total acquisition cost may increase when the costs of storage and inventory are included.
A low acquisition cost still may not be a good decision when the total costs to
the company are considered. For example, a carpenter will pay a lower price for a
lower grade of wood. However, the time spent on sorting out knots and defects and
the decreased yield of good material will incur production-related costs, which will
increase the total cost of the final product, perhaps cancelling any savings made in
price. The total cost concept looks at the total costs to the system and not at just the
price paid for materials.
In a modern business environment, the type of relationship between the supplier and the buyer is crucial to both. Ideally, the relationship will be ongoing with a
mutual dependency. The supplier can rely on future business, and the buyer will be
ensured of a supply of quality product, technical support, and product improvement.
Communications between buyer and supplier must be open and full so both parties
understand the problems of the other and can work together to solve problems to
their mutual advantage. Thus, supplier selection and supplier relations are of the
utmost importance.
Identifying Suppliers
One major responsibility of the purchasing department is to continue to research all
available sources of supply. Some aids for identifying sources of supply follow:
• Salespersons of the supplier company.
• Internet.
Purchasing
•
•
•
•
203
Catalogues.
Trade magazines.
Trade directories.
Information obtained by the salespeople of the buyer firm.
Final Selection of Supplier
Some factors in evaluating potential suppliers are quantitative, and a dollar value can
be put on them. Price is the obvious example. Other factors are qualitative and
demand some judgment to determine them. These are usually set out in a descriptive
fashion. The supplier’s technical competence might be an example.
The challenge is finding some method of combining these two major factors
that will enable a buyer to pick the best supplier. One method is the ranking method,
described next.
1. Select those factors that must be considered in evaluating potential suppliers.
2. Assign a weight to each factor. This weight determines the importance of the
factor in relation to the other factors. Usually a scale of 1 to 10 is used. If
one factor is assigned a weight of 5 and another factor a weight of 10, the
second factor is considered twice as important as the first. When developing
the factors and their weights, the buyer can use input from the people who will
be affected by the supplier selection. This will help the buyer in making a
more informed decision and will improve the acceptance of the new supplier
by the users.
3. Rate the suppliers for each factor. This rating is not associated with the weight.
Rather, suppliers are rated on their ability to meet the requirements of each
factor. Again, usually a scale of 1 to 10 is used.
4. Rank the suppliers. For each supplier, the weight of each factor is multiplied by
the supplier rating for that factor. For example, if a factor had a weight of 8 and
a supplier was rated 3 for that factor, the ranking value for that factor would be
24. The supplier rankings are then added to produce a total ranking. The
suppliers can then be listed by total ranking and the supplier with the highest
ranking chosen.
Figure 7.1 shows an example of this method of selecting suppliers. Supplier B
has the highest total of 223; however, supplier D comes in a very close second with
222. The normal practice when using the ranking method is to eliminate the bottom
ranking suppliers from consideration, allowing management to make a simpler
decision.
The ranking method is an attempt to quantify those things that are not quantified by nature. It attempts to put figures on subjective judgment. It is not a perfect
method, but it forces the buying company to consider the relative importance of the
various factors. When the method includes the input of many people in determining
the relative weights, agreement on the final selection will be improved.
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Factor
Weight
Suppliers
Function
Cost
Service
Technical
Assistance
Credit
Terms
Rating of
Suppliers
Ranking of
Suppliers
A
B
C
D
A
B
C
D
10
8
8
8
3
9
10
5
4
6
9
5
6
10
7
80
24
72
100
40
32
60
72
40
60
80
56
5
7
9
4
2
35
45
20
10
2
4
3
6
8
8
6
12
16
219
223
204
222
Total (rank of suppliers)
Figure 7.1 Supplier rating.
PRICE DETERMINATION
Price is not the only factor in making purchasing decisions. However, all other things
being equal, it is the most important. In the average manufacturing company,
purchases account for about 50% of the cost of goods sold, and any savings made in
purchase cost has a direct influence on profits.
However, remember that “you only get what you pay for.” The trick is to know what
you want and not pay more than necessary. When a purchase is made, the buyer receives
a package of function, quantity, service, and price characteristics that are suited to the
individual’s needs. The idea of “best buy” is the mixture that serves the purpose best.
Basis for Pricing
The term fair price is sometimes used to describe what should be paid for an item. But
what is a fair price? One answer is that it is the lowest price at which the item can be
bought. However, there are other considerations, especially for repeat purchases
where the buyer and seller want to establish a good working relationship. One definition of a fair price is one that is competitive, gives the seller a profit, and allows the
buyer ultimately to sell at a profit. Sellers who charge too little to cover their costs will
not stay in business. To survive, they may attempt to cut costs by reducing quality and
service. In the end, both the buyer and seller must be satisfied.
Since we want to pay a fair price and no more, it is good to develop some basis
for establishing what is a fair price.
Prices have an upper and a lower limit. The market decides the upper limit.
What buyers are willing to pay is based on their perception of demand, supply, and
their needs. The seller sets the lower limit. It is determined by the costs of manufacturing and selling the product and profit expectation. If buyers are to arrive at a fair
price, they must develop an understanding of market demand and supply, competitive prices, and the methods of arriving at a cost.
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Purchasing
One widely used method of analyzing costs is to break them down into fixed and
variable costs. Fixed costs are costs incurred no matter the volume of sales. Examples
are equipment depreciation, taxes, insurance, and administrative overhead. Variable
costs are those directly associated with the amount produced or sold. Examples are
direct labor, direct material, and commissions of the sales force.
Total cost = fixed cost + 1variable cost per unit21number of units2
total cost
Unit 1average2 cost =
number of units
=
fixed cost
+ variable cost per unit
number of units
The preceding formula shows that as the number of units produced increases, the
unit cost decreases. This is an important factor when determining price. Buyers can
lower the unit price paid by increasing the volume per order using longer-term contracts
or through the standardization of parts. Sellers will offer quantity discounts to encourage
larger orders, also taking advantage of this reduction in unit cost. Quantity discounts are
discussed later in Chapter 10, and standardization is discussed in Chapter 14.
Figure 7.2 shows the relationship of fixed and variable costs to sales volume and
how revenue will behave. The sum of the fixed and variable costs is labeled total cost
on the graph. The third line represents the sales revenue. Where this line intercepts
the total cost line, revenue equals total cost, and profit is zero. This is called the
break-even point. When the volume is less than the break-even point, a loss is
incurred; when the volume is greater, a profit is realized. The break-even point occurs
where the revenue equals the total cost.
Revenue = total cost
(Price per unit)(number of units sold) fixed cost (variable cost per unit)
(number of units)
DOLLARS
Revenue
Total Cost
Loss Profit
Break-Even Point
SALES VOLUME
Figure 7.2 Break-even analysis.
Fixed Cost
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EXAMPLE PROBLEM
To make a particular component requires an overhead (fixed) cost of $5000 and a
variable unit cost of $6.50 per unit. What is the total cost and the average cost of
producing a lot of 1000? If the selling price is $15 per unit, what is the break-even
point?
Answer
Total cost
Average cost
Break-even point: Let X
$15X
$8.50X
X
=
=
=
=
=
=
$5000 + 1$6.50 * $10002 = $11,500
$11,500 , 1000 = $11.50 per unit
number of units sold
$5000 + $6.5X
$5000
588.2 units
Break-even occurs when 588.2 units are made and sold.
Competitive Bidding
Competitive bidding occurs when a buyer compares the price of a product from
various suppliers and simply chooses the lowest price. This can be the formal process
of sending out quotations and analyzing the results or simply comparing catalogue or
advertised prices. The process does take some time, and a number of sources must be
available. At least three sources are desired to make a good comparison. Competitive
bidding also requires that the product be well specified and widely available.
Items such as nuts and bolts, gasoline, bread, and milk are usually sourced using
competitive bidding.
Price Negotiation
Prices can be negotiated if the buyer has the knowledge and the clout to do so. A small
retailer probably has little of the latter, but a large buyer may have much. Through
negotiation, the buyer and seller try to resolve conditions of purchase to the mutual
benefit of both parties. Skill and careful planning are required for the negotiation to
be successful. It also takes a great deal of time and effort, so the potential profit must
justify the expense.
One important factor in the approach to negotiation is the type of product.
There are four categories:
1. Commodities. Commodities are materials such as copper, coal, wheat, meat,
and metals. Price is set by market supply and demand and can fluctuate widely.
Negotiation is concerned with contracts for future prices.
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207
2. Standard products. These items are provided by many suppliers. Since the items
are standard and the choice of suppliers large, prices are determined on the
basis of listed catalog prices. There is not much room for negotiation except for
large purchases.
3. Items of small value. These are items such as maintenance or cleaning supplies
and represent purchases of such small value that price negotiation is of little
purpose. The prime objective should be to keep the cost of ordering low. Firms
will negotiate a contract with a supplier that can supply many items and set up a
simple ordering system that reduces the cost of ordering.
4. Made-to-order items. This category includes items made to specification or for
which quotations from several sources are received. These can generally be
negotiated.
IMPACT OF MATERIAL REQUIREMENTS PLANNING ON PURCHASING
The text in this chapter has described the traditional role and responsibilities of purchasing. This section will study the effect material requirements planning (MRP) has
on the purchasing function and the changing role of purchasing.
Purchasing can be separated into two types of activities: (1) procurement and
(2) supplier scheduling and follow-up. Much of what has been covered in this chapter is in the area of procurement. Procurement includes the functions of establishing
specifications, selecting suppliers, price determination, and negotiation. Supplier
scheduling and follow-up are concerned with the release of orders to suppliers,
working with suppliers to schedule delivery, and follow-up. The goals of supplier
scheduling are the same as those of production activity control: to execute the master production schedule and the material requirements plan, ensure good use of
resources, minimize work-in-process inventory, and maintain the desired level of
customer service.
Planner/buyer concept. In a traditional system, the material requirements
planner releases an order either to production activity control or to purchasing.
Purchasing issues purchase orders based on the material requirements plan.
Production activity control prepares shop orders, schedules components into the
work flow, and controls material progress through the plant. When plans change, as
they invariably do, the production planner must advise the buyer of the change, and
the buyer must advise the supplier. The production planner is in closer, more
continuous contact with MRP and frequently changing schedules than is the buyer.
To improve the effectiveness of the planner/buyer activity, many companies have
combined the two functions of buying and planning.
Sometimes the planner’s job and the buyer’s job are combined into a single job
done by one person. Planner/buyers do the material planning for the items under their
control, communicate the schedules to their suppliers, follow up, resolve problems,
and work with other planners and the master scheduler when delivery problems arise.
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The planner/buyer handles fewer components than either a planner or a buyer but
has the responsibilities of both. The planner/buyer is responsible for:
•
•
•
•
•
•
•
Determining material requirements.
Developing schedules.
Issuing shop orders.
Issuing material releases to suppliers.
Establishing delivery priorities.
Controlling orders in the factory and to suppliers.
Handling all the activities associated with the buying and production scheduling
functions.
• Maintaining close contact with supplier personnel.
Because the role of production planning and buying are combined, there is a
smoother flow of information and material between the supplier and the factory. The
planner/buyer has a keener knowledge of factory needs than the buyer does and can
better coordinate the material flow with suppliers. At the same time, the planner/
buyer is better able to match material requirements with supplier’s manufacturing
capabilities and constraints.
Contract buying. Usually a material requirements planning system generates frequent orders for relatively small quantities. This is particularly true for components that
are ordered lot-for-lot. It is costly, inefficient, and sometimes impossible to issue a new
purchase order for every weekly requirement. The alternative is to develop a long-term
contract with a supplier and to authorize releases against the contract. Often suppliers
are given a copy of the material requirements plan so they are aware of future demands.
The buyer then issues a release against the schedule. This approach is efficient and
cost-effective but requires close coordination and communication with the supplier.
Again, contract buying can be managed very well by a planner/buyer.
Supplier responsiveness and reliability. Because material requirements often
change, suppliers must be able to react quickly to change. They must be highly flexible and reliable so they can react quickly to changes in schedules.
Contract buying ensures suppliers a given amount of business and commits
them to allocating that amount of their capacity to the customer. Suppliers are more
responsive to customer needs and can react quickly to changes in schedules. Because
customers know the capacity will be available when needed, they can delay ordering
until they are more sure of their requirements.
Close relationship with suppliers. Contract buying and the need for supplier
flexibility and reliability mean the buyer–supplier relationship must be close and cooperative. There must be excellent two-way communication, cooperation, and teamwork.
Both parties have to understand their own and the other’s operations and problems.
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209
The planner/buyer and the supplier counterpart (often the supplier’s production planner) must work on a weekly basis to ensure both parties are aware of any
changes in material requirements or material availability.
Electronic data interchange (EDI). Electronic data interchange (EDI) enables
customers and suppliers to electronically exchange transaction information such as
purchase orders, invoices, and material requirements planning information. This
eliminates time-consuming paperwork and facilitates easy communication between
planner/buyers and suppliers.
Vendor-managed inventory. In recent years there has been a growth in the purchasing approach known as vendor-managed inventory. In this concept, a supplier
maintains an inventory of certain items in the customer’s facility. The supplier “owns”
the inventory until the customer actually withdraws it for use, after which the customer then pays for that use. The customer does not have to order any of the inventory, as the supplier is responsible for maintaining an adequate supply in the facility
for customer use. This approach is most commonly used for lower-value products
that have a relatively standard design, such as fasteners, standard electrical equipment, etc.
Internet. Internet technology has become the most quickly accepted communications medium ever. There are three variations of networks used: Internet, intranet,
and extranet. The Internet is most commonly used and is open to the general public.
An intranet is an internal net that is normally used within the boundaries of a company. It may stretch across many manufacturing sites or even countries. Much of the
data shared in this environment is considered sensitive, and therefore access is usually limited to people within the company. Extranet is an intranet shared by two or
more companies. Each participating company moves certain data outside of a private
intranet to the extranet, making it available only to the companies sharing the
extranet. (A supplier may be provided with information such as the planned order
releases or the stock status of an item.)
EXPANSION OF PURCHASING INTO SUPPLY CHAIN MANAGEMENT
As computers and software (ERP, for example) have become more powerful and
effective, information flows have become easier and the ability to handle large
amounts of data has become more feasible. This condition has allowed companies to
expand their planning and control perspectives to include “upstream” (suppliers) and
“downstream” (distributors and customers) entities. This concept of the supply chain
has four major components that are managed:
• The flow of physical materials from suppliers, downstream through the company
itself, and finally to distributors and/or customers.
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• The flow of money upstream from customers back to the companies and suppliers.
• The flow of information up and down through the stream.
• The flow of products back (upstream) from the customers, typically for repairs
or recycling.
Other entities also have impact on the supply chain for a company. A major
example is governments, which can impact the supply chain both positively and negatively. The word governments is plural since many modern supply chains are global in
nature, often including companies and customers from many different countries
around the world.
Although several impacts on the supply chain perspective have been observed
and formalized, two in particular have become formalized and noteworthy:
• Customer relationship management (CRM) includes several activities with the
intent to build and maintain a strong customer base. Customer wants and needs
are assessed and cross-functional teams from the company work to align company activities around those customer needs
• Supplier relationship management (SRM) is similar to CRM, only the focus for
these activities is the building and maintaining of close, long-term relationships
with key suppliers.
One critical reason for developing formal links and relationships in the supply
chain is to help control the “bullwhip effect.” This effect occurs when there is uncertainty in the supply chain based on the use of forecasts, and that uncertainty is then
exaggerated by lead-time effects and differences in lot sizes as material moves
through the supply chain.
The effect can produce large fluctuations in demand for raw materials
based on relatively small changes in demand from the customer end of the supply
chain. Managing the supply chain with visibility of data (information flow) and
building flexibility and agility across the supply chain can substantially reduce large
fluctuations.
The management required to effectively manage the supply chain is heavily
based on managing data and inventory, but there are other aspects as well. Good
strategic planning focusing on anticipating and preparing for disruptions and sharing
those risks among other entities in the supply chain represent examples of the types
of supply chain management that have been developed.
Another key issue that has grown in importance with the growth of supply chain
is the focus on ethics. People in purchasing and supply chain positions often have
responsibility for managing the flow of a great deal of money, and as a result it
becomes quite important to have honest and ethical conduct on the part of those
people. Many companies, and countries, have developed strict codes and rules of
conduct to ensure consistent and ethical treatment of the supply chain activities and
reported measures.
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SOME ORGANIZATIONAL IMPLICATIONS OF SUPPLY CHAIN MANAGEMENT
Organizations that alter their perspective away from traditional purchasing toward
supply chain management must recognize that their perspective toward managing the
entire organization must also change. For instance, most organizations that have
adopted a supply chain perspective find the following:
• Their cost focus has altered dramatically. Often decisions are not based on just
product price but instead on total cost and value. This implies an integrated
view of price, quality, serviceability, durability, and any other characteristic that
the company places on total value. It also can include transportation, storage,
and material handling costs. To accomplish this changed perspective, organizations have adopted techniques of process analysis, value stream analysis, and
mutual (between the company and its suppliers) value analysis.
• Cross-functional teams are now used to plan and control the supply chain.
These teams are made up of representatives from various departments
including production, quality control, engineering, finance, purchasing, and so on.
Cross-functional teams make decisions more quickly than traditional departmental organizations and also are likely to consider overall benefits to the
company, not just benefits to the individual departments.
• Decision making has changed from the “I say and you do” or a negotiated
perspective with suppliers to one of “Let’s talk about the best way to handle this
and make a mutually advantageous decision.” This also implies very long supplier contracts.
• Information sharing has changed from simply giving out information about the
order to the perspective of sharing some important information about the business itself.
• Measurement systems look at all aspects of the supply chain and not just supplier performance.
• There is a growth in electronic business (e-business). This implies using the
Internet more for handling business information flows and transactions.
Savings Can Be Substantial
There are many advantages associated with an effective supply chain perspective.
Some of these savings include:
• More effective product specification, allowing for efficient product substitutions and product specifications focused on fitness of use.
• Better leveraging of volume discounts and supplier consolidation.
• Long-term contracts with efficient communication systems, significantly reducing the administrative cost of ordering and order tracking.
• More effective use of techniques such as electronic commerce, using credit
cards for payments, and blanket ordering.
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KEY TERMS
Purchasing cycle 193
Functional specifications 196
Value analysis 197
Buyer specifications 199
Standard specifications 199
Ranking method 203
Fair price 204
Fixed costs 205
Variable costs 205
Break-even point 205
Planner/buyers 207
Contract buying 208
Supplier flexibility and
reliability 208
Electronic data interchange
(EDI) 209
Vendor-managed inventory
209
Internet 209
Intranet 209
Extranet 209
Customer relationship
management (CRM) 210
Supplier relationship
management (SRM) 210
Bullwhip effect 210
QUESTIONS
1. What are four objectives of purchasing?
2. List the seven steps in the purchasing cycle.
3. Describe the purposes, similarities, and differences among purchase requisitions, purchase orders, and requests for quotation.
4. What are the responsibilities of the purchasing department in follow-up?
5. Describe the duties of the receiving department upon receipt of goods.
6. Besides functional specifications, what three other specifications must be determined?
Why is each important?
7. What is quality?
8. Name and describe the four phases of quality. How do they interrelate? Who is responsible for quality?
9. Describe the advantages and disadvantages of the following ways of describing functional requirements. Give examples of when each is used.
a. By brand.
b. By specification of physical and chemical characteristics, material and method of
manufacture, and performance.
10. What are the advantages of using standard specifications?
11. Why is it important to select the right supplier and to maintain a relationship with him
or her?
12. Name and describe the three types of sourcing.
13. Describe the six factors that should be used in selecting a supplier.
14. What is the concept of “best buy”?
15. Type of product is a factor that influences the approach to negotiation. Name the four
categories of products and state what room there is for negotiation.
16. What are four savings that can result from adopting a supply chain management
approach?
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PROBLEMS
7.1
If purchases were 45% of sales and other expenses were 45% of sales, what would be the
increase in profit if, through better purchasing, the cost of purchases was reduced to
43% of sales?
7.2
If suppliers were to be rated on the following basis, what would be the ranking of the two
suppliers listed?
Factor
Function
Cost
Technical Assistance
Credit Terms
7.3
Weight
8
5
7
2
Rating of Suppliers
Supplier A
Supplier B
8
9
9
5
5
7
8
4
Ranking of Suppliers
Supplier A
Supplier B
A company is negotiating with a potential supplier for the purchase of 10,000 widgets.
The company estimates that the supplier’s variable costs are $5 per unit and that the
fixed costs, depreciation, overhead, and so on, are $5000. The supplier quotes a price of
$10 per unit. Calculate the estimated average cost per unit. Do you think $10 is too much
to pay? Could the purchasing department negotiate a better price?
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LET’S PARTY!
“Let’s party!” is still echoing in your head as you leave your Principles of Buying class.
Again you ask yourself, “Why did I ever let myself run for class president?” Most of
the people in the class were good, level-headed individuals who enjoyed a good time
and you enjoyed working with them. But a small group from your class, who were
known on campus as The Rowdies, often bullied their way on decisions affecting class
activities. The decision to have a year-end party was right up their alley, and class had
ended with a chanting session of “Let’s party.” It sounded like a wrestling match to
you. Fortunately, your professor had left the room early to let you discuss with the
class the idea of some kind of year-end get-together.
The Rowdies had immediately suggested the Goat’s Ear, a local hangout with
not much to offer but cheap drinks. The rest of your classmates had put forth some
other suggestions, but no consensus on a location could be reached between the
members of your executive committee or the rest of the class. If you went to the
Goat’s Ear most of the sane people in your class wouldn’t attend, and even when you
suggested more conventional locations, people couldn’t agree because of factors such
as the type of music played.
Since there were only two weeks left until the end of regular classes, you felt that
you had to make arrangements in a hurry. It wasn’t difficult to identify the most popular possible locations, but getting agreement from this group was going to be difficult.
One of your recent lectures was on supplier selection, and your professor had
demonstrated the technique called the ranking or weighted-point method. It seemed
simple enough in the lecture, and you had almost embarrassed yourself by asking the
question “Why not just pick the least expensive supplier?” The thought occurred to
you that there just might be some solution to your current problem in the professor’s
response, “One of the hardest things to do in any group, whether a business or a
social club, is to get consensus on even the simplest choices.”
Case Analysis
For this exercise, put yourself in the position of the class president described in this
case and complete one of the two following exercises:
Exercise 1
1. Perform a supplier rating analysis for the situation. Include at least ten factors and four
possible locations.
2. Make the selection as indicated by the analysis.
3. Discuss why the analysis led to your selection in step 2 and whether you would change
any of the criteria or weights.
Exercise 2
1. Prepare a transparency to be used in class to make a selection for a year-end get-together.
2. Lead a discussion to determine at least four possible locations and ten factors.
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215
3. Have the class agree on weighting factors for each criteria.
4. Perform the calculations and make the selection.
5. Discuss with the class why the analysis led to the selection in step 2 and whether you
would change any of the criteria or weights.
6. Ask the class members whether they feel more in agreement with the decision after
going through this process.
8
Forecasting
INTRODUCTION
Forecasting is a prelude to planning. Before making plans, an estimate must be made
of what conditions will exist over some future period. How estimates are made, and
with what accuracy, is another matter, but little can be done without some form of
estimation.
Why forecast? There are many circumstances and reasons, but forecasting is
inevitable in developing plans to satisfy future demand. Most firms cannot wait until
orders are actually received before they start to plan what to produce. Customers
usually demand delivery in reasonable time, and manufacturers must anticipate
future demand for products or services and plan to provide the capacity and
resources to meet that demand. Firms that make standard products need to have
saleable goods immediately available or at least to have materials and subassemblies
available to shorten the delivery time. Firms that make-to-order cannot begin making
a product before a customer places an order but must have the resources of labor and
equipment available to meet demand.
Many factors influence the demand for a firm’s products and services. Although
it is not possible to identify all of them, or their effect on demand, it is helpful to consider some major factors:
• General business and economic conditions.
• Competitive factors.
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217
Forecasting
• Market trends such as changing demand.
• The firm’s own plans for advertising, promotion, pricing, and product changes.
DEMAND MANAGEMENT
The prime purpose of an organization is to serve the customer. Marketing focuses on
meeting customer needs, but operations, through materials management, must provide
the resources. The coordination of plans by these two parties is demand management.
Demand management is the function of recognizing and managing all demands
for products. It occurs in the short, medium, and long term. In the long term, demand
projections are needed for strategic business planning of such things as facilities. In
the medium term, the purpose of demand management is to project aggregate
demand for production planning. In the short run, demand management is needed
for items and is associated with master production scheduling. We are most concerned with the latter.
If material and capacity resources are to be planned effectively, all sources of
demand must be identified. These include domestic and foreign customers, other
plants in the same corporation, branch warehouses, service parts and requirements,
promotions, distribution inventory, and consigned inventory in customers’ locations.
Demand management includes four major activities:
• Forecasting.
• Order processing.
• Making delivery promises. The concept of available-to-promise was discussed
in Chapter 3.
• Interfacing between manufacturing planning and control and the marketplace.
Figure 8.1 shows this relationship graphically.
In each of these cases, production (supply) is being planned to react to anticipated
demand as shown by the forecast.
Order processing. Order processing occurs when a customer’s order is received. The
product may be delivered from finished goods inventory or it may be made or assembled
PRODUCTION
PLANNING
MARKETPLACE
DEMAND
MANAGEMENT
MASTER
PRODUCTION
SCHEDULE
Figure 8.1 Demand management and the manufacturing planning and control system.
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to order. If goods are sold from inventory, a sales order is produced authorizing the
goods to be shipped from inventory. If the product is made or assembled to order, the
sales department must write up a sales order specifying the product. This may be relatively simple if the product is assembled from standard components but can be a
lengthy, complex process if the product requires extensive engineering. A copy of the
sales order stating the terms and conditions of acceptance of the order is sent to the
customer. Another copy, sent to the master planner, is authorization to go ahead and
plan for manufacture. The master planner must know what to produce, how much,
and when to deliver. The sales order must be written in language that makes this
information clear.
DEMAND FORECASTING
Forecasts depend upon what is to be done. They must be made for the strategic business plan, the production plan, and the master production schedule. As discussed in
Chapter 2, the purpose, planning horizons, and level of detail vary for each.
The strategic business plan is concerned with overall markets and the direction
of the economy over the next 2 to 10 years or more. Its purpose is to provide time to
plan for those things that take long to change. For production, the strategic business
plan should provide sufficient time for resource planning: plant expansion, capital
equipment purchase, and anything requiring a long lead time to purchase. The level
of detail is not high, and usually forecasts are in sales units, sales dollars, or capacity.
Forecasts and planning will probably be reviewed quarterly or yearly.
Production planning is concerned with manufacturing activity for the next one to
three years. For manufacturing, it means forecasting those items needed for production planning, such as budgets, labor planning, long lead time, procurement items, and
overall inventory levels. Forecasts are made for groups or families of products rather
than specific end items. Forecasts and plans will probably be reviewed monthly.
Master production scheduling is concerned with production activity from the present to a few months ahead. Forecasts are made for individual items, as found on a master production schedule, individual item inventory levels, raw materials and component
parts, labor planning, and so forth. Forecasts and plans will probably be reviewed weekly.
CHARACTERISTICS OF DEMAND
In this chapter, the term demand is used rather than sales. The difference is that sales
implies what is actually sold whereas demand shows the need for the item. Sometimes
demand cannot be satisfied, and sales will be less than demand.
Before discussing forecasting principles and techniques, it is best to look at
some characteristics of demand that influence the forecast and the particular techniques used.
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Forecasting
5
Trend
DEMAND
4
3
2
Seasonal
Demand
1
0
1
2
3
4
1
5
6
7
QUARTERS
2
YEARS
8
9
10
11
12
3
Figure 8.2 Demand over time.
Demand Patterns
If historical data for demand are plotted against a time scale, they will show any
shapes or consistent patterns that exist. A pattern is the general shape of a time
series. Although some individual data points will not fall exactly on the pattern, they
tend to cluster around it.
Figure 8.2 shows a hypothetical historical demand pattern. The pattern shows
that actual demand varies from period to period. There are four reasons for this:
trend, seasonality, random variation, and cycle.
Trend. Figure 8.2 shows that demand is increasing in a steady pattern of demand
from year to year. This graph illustrates a linear trend, but there are different shapes,
such as geometric or exponential. The trend can be level, having no change from
period to period, or it can rise or fall.
Seasonality. The demand pattern in Figure 8.2 shows each year’s demand fluctuating depending on the time of year. This fluctuation may be the result of the
weather, holiday seasons, or particular events that take place on a seasonal basis.
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Chapter 8
Seasonality is usually thought of as occurring on a yearly basis, but it can also occur
on a weekly or even daily basis. A restaurant’s demand varies with the hour of the
day, and supermarket sales vary with the day of the week.
Random variation. Random variation occurs where many factors affect demand
during specific periods and occur on a random basis. The variation may be small, with
actual demand falling close to the pattern, or it may be large, with the points widely
scattered. The pattern of variation can usually be measured, and this will be discussed
in the section on tracking the forecast.
Cycle. Over a span of several years and even decades, wavelike increases and
decreases in the economy influence demand. However, forecasting of cycles is a job
for economists and is beyond the scope of this text.
Stable Versus Dynamic
The shapes of the demand patterns for some products or services change over time
whereas others do not. Those that retain the same general shape are called stable and
those that do not are called dynamic. Dynamic changes can affect the trend, seasonality, or randomness of the actual demand. The more stable the demand, the easier it
is to forecast. Figure 8.3 shows a graphical representation of stable and dynamic
demand. Notice the average demand is the same for both stable and dynamic patterns. It is usually the average demand that is forecast.
Dependent Versus Independent Demand
Chapter 4 discussed dependent and independent demand. It was said that demand
for a product or service is independent when it is not related to the demand for any
other product or service. Dependent demand for a product or service occurs where
the demand for the item is derived from that of a second item. Requirements for
Dynamic
Stable
Average
Demand
Figure 8.3 Stable and dynamic demand.
Forecasting
221
dependent demand items need not be forecast but are calculated from that of the
independent demand item.
Only independent demand items need to be forecasted. These are usually end
items or finished goods but should also include service parts and items supplied to
other plants in the same company (intercompany transfers).
PRINCIPLES OF FORECASTING
Forecasts have four major characteristics or principles. An understanding of these
will allow us to make more effective use of forecasts. They are simple and, to some
extent, common sense.
1. Forecasts are usually wrong. Forecasts attempt to look into the unknown future
and, except by sheer luck, will be wrong to some degree. Errors are inevitable
and must be expected.
2. Every forecast should include an estimate of error. Since forecasts are expected to
be wrong, the real question is “By how much?” Every forecast should include an
estimate of error often expressed as a percentage (plus and minus) of the forecast or as a range between maximum and minimum values. Estimates of this
error can be made statistically by studying the variability of demand about the
average demand.
3. Forecasts are more accurate for families or groups. The behavior of individual
items in a group is random even when the group has very stable characteristics.
For example, the marks for individual students in a class are more difficult to
forecast accurately than the class average. High marks average out with low
marks. This means that forecasts are more accurate for large groups of items
than for individual items in a group.
For production planning, families or groups are based on the similarity of
process and equipment used. For example, a firm forecasting the demand for
knit socks as a product group might forecast men’s socks as one group and
women’s as another since the markets are different. However, production of
men’s and women’s ankle socks will be done on the same machines and knee
socks on another. For production planning, the forecast should be for (a) men’s
and women’s ankle socks and (b) men’s and women’s knee socks.
4. Forecasts are more accurate for nearer time periods. The near future holds less
uncertainty than the far future. Most people are more confident in forecasting
what they will be doing over the next week than a year from now. As someone
once said, tomorrow is expected to be pretty much like today.
In the same way, demand for the near term is easier for a company to
forecast than for a time in the distant future. This is extremely important for
long-lead-time items and especially so if their demand is dynamic. Anything
that can be done to reduce lead time will improve forecast accuracy.
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COLLECTION AND PREPARATION OF DATA
Forecasts are usually based on historical data manipulated in some way using either
judgment or a statistical technique. Thus, the forecast is only as good as the data on
which it is based. To get good data, three principles of data collection are important.
1. Record data in the same terms as needed for the forecast. This is a problem in
determining the purpose of the forecast and what is to be forecast. There are
three dimensions to this:
a. If the purpose is to forecast demand on production, data based on demand,
not shipments, are needed. Shipments show when goods were shipped and
not necessarily when the customer wanted them. Thus shipments do not
necessarily give a true indication of demand.
b. The forecast period, in weeks, months, or quarters, should be the same as
the schedule period. If schedules are weekly, the forecast should be for the
same time interval.
c. The items forecast should be the same as those controlled by manufacturing. For example, if there are a variety of options that can be supplied with a
particular product, the demand for the product and for each option should
be forecast.
Suppose a firm makes a bicycle that comes in three frame sizes, three possible
wheel sizes, a 3-, 5-, or 10-speed gear changer, and with or without deluxe trim.
In all, there are 54 13 * 3 * 3 * 22 individual end items sold. If each were
forecast, there would be 54 forecasts to make. A better approach is to forecast
(a) total demand and (b) the percentage of the total that requires each frame
size, wheel size, and so on. That way there need be only 12 forecasts (three
frames, three wheels, five gears, and the bike itself).
In this example, the lead time to make the components would be relatively
long in comparison to the lead time to assemble a bike. Manufacturing can
make the components according to component forecast and can then assemble
bikes according to customer orders. This would be ideal for situations where
final assembly schedules are used.
2. Record the circumstances relating to the data. Demand is influenced by particular
events, and these should be recorded along with the demand data. For instance,
artificial bumps in demand can be caused by sales promotions, price changes,
changes in the weather, or a strike at a competitor’s factory. It is vital that these
factors be related to the demand history so they may be included or removed
for future conditions.
3. Record the demand separately for different customer groups. Many firms distribute
their goods through different channels of distribution, each having its own
demand characteristics. For example, a firm may sell to a number of wholesalers that order relatively small quantities regularly and also sell to a major
Forecasting
223
retailer that buys a large lot twice a year. Forecasts of average demand would be
meaningless, and each set of demands should be forecast separately.
FORECASTING TECHNIQUES
There are many forecasting methods, but they can usually be classified into three categories: qualitative, extrinsic, and intrinsic.
Qualitative Techniques
Qualitative techniques are projections based on judgment, intuition, and informed
opinions. By their nature, they are subjective. Such techniques are used to forecast
general business trends and the potential demand for large families of products over
an extended period of time. As such, they are used mainly by senior management.
Production and inventory forecasting is usually concerned with the demand for particular end items, and qualitative techniques are seldom appropriate.
When attempting to forecast the demand for a new product, there is no history
on which to base a forecast. In these cases, the techniques of market research and historical analogy might be used. Market research is a systematic, formal, and conscious
procedure for testing to determine customer opinion or intention. Historical analogy
is based on a comparative analysis of the introduction and growth of similar products
in the hope that the new product behaves in a similar fashion. Another method is to
test-market a product.
There are several other methods of qualitative forecasting. One, called the Delphi
method, uses a panel of experts who give their opinions on what is likely to happen.
Extrinsic Techniques
Extrinsic forecasting techniques are projections based on external (extrinsic) indicators which relate to the demand for a company’s products. Examples of such data
would be housing starts, birth rates, and disposable income. The theory is that the
demand for a product group is directly proportional, or correlates, to activity in
another field. Examples of correlation are:
• Sales of bricks are proportional to housing starts.
• Sales of automobile tires are proportional to gasoline consumption.
Housing starts and gasoline consumption are called economic indicators. They
describe economic conditions prevailing during a given time period. Some commonly
used economic indicators are construction contract awards, automobile production,
farm income, steel production, and gross national income. Data of this kind are compiled and published by various government departments, financial papers and magazines, trade associations, and banks.
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Chapter 8
The problem is to find an indicator that correlates with demand and one that
preferably leads demand, that is, one that occurs before the demand does. For example, the number of construction contracts awarded in one period may determine the
building material sold in the next period. When it is not possible to find a leading
indicator, it may be possible to use a nonleading indicator for which the government
or an organization forecasts. In a sense, it is basing a forecast on a forecast.
Extrinsic forecasting is most useful in forecasting the total demand for a firm’s
products or the demand for families of products. As such, it is used most often in
business and production planning rather than the forecasting of individual end items.
Intrinsic Techniques
Intrinsic forecasting techniques use historical data to forecast. These data are usually
recorded in the company and are readily available. Intrinsic forecasting techniques
are based on the assumption that what happened in the past will happen in the future.
This assumption has been likened to driving a car by looking out the rearview mirror.
Although there is some obvious truth to this, it is also true that lacking any other crystal ball, the best guide to the future is what has happened in the past.
Since intrinsic techniques are so important, the next section will discuss some of
the more important techniques. They are often used as input to master production
scheduling where end-item forecasts are needed for the planning horizon of the plan.
SOME IMPORTANT INTRINSIC TECHNIQUES
Assume that the monthly demand for a particular item over the past year is as shown
in Figure 8.4.
Suppose it is the end of December, and we want to forecast demand for January
of the coming year. Several rules can be used:
• Demand this month will be the same as last month. January demand would be
forecast at 84, the same as December. This may appear too simple, but if there
is little change in demand month to month, it probably will be quite usable.
• Demand this month will be the same as demand the same month last year.
Forecast demand would be 92, the same as January last year. This rule is adequate if demand is seasonal and there is little up or down trend.
Figure 8.4 A 12-month
demand history.
January
February
March
April
May
June
92
83
66
74
75
84
July
August
September
October
November
December
84
81
75
63
91
84
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Forecasting
Rules such as these, based on a single month or past period, are of limited use
when there is much random fluctuation in demand. Usually methods that average out
history are better because they dampen out some effects of random variation.
As an example, the average of last year’s demand can be used as an estimate for
January demand. Such a simple average would not be responsive to trends or changes
in level of demand. A better method would be to use a moving average.
Average demand. This raises the question of what to forecast. As discussed previously, demand can fluctuate because of random variation. It is best to forecast the
average demand rather than second-guess what the effect of random fluctuation will
be. The second principle of forecasting discussed previously said that a forecast
should include an estimate of error. As we will see, this range can be estimated. Thus,
a forecast of average demand should be made, and the estimate of error applied to it.
Moving Averages
One simple way to forecast is to take the average demand for, say, the last three or six
periods and use that figure as the forecast for the next period. At the end of the next
period, the first-period demand is dropped and the latest-period demand added to
determine a new average to be used as a forecast. This forecast would always be
based on the average of the actual demand over the specified period.
For example, suppose it was decided to use a three-month moving average on
the data shown in Figure 8.4. Our forecast for January, based on the demand in
October, November, and December, would be:
63 + 91 + 84
= 79
3
Now suppose that January demand turned out to be 90 instead of 79. The forecast for February would be calculated as:
91 + 84 + 90
= 88
3
EXAMPLE PROBLEM
Demand over the past three months has been 120, 135, and 114 units. Using a threemonth moving average, calculate the forecast for the fourth month.
Answer
Forecast for month 4 =
120 + 135 + 114
369
=
= 123
3
3
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Chapter 8
Actual demand for the fourth month turned out to be 129. Calculate the forecast for the fifth month.
Forecast for month 5 =
135 + 114 + 129
= 126
3
In the previous discussion, the forecast for January was 79, and the forecast for
February was 88. The forecast has risen, reflecting the higher January value and the
dropping of the low October value. If a longer period, such as six months, is used, the
forecast does not react as quickly. The fewer months included in the moving average,
the more weight is given to the latest information, and the faster the forecast reacts to
trends. However, the forecast will always lag behind a trend. For example, consider
the following demand history for the past five periods:
Period
Demand
1
1000
2
2000
3
3000
4
4000
5
5000
There is a rising trend to demand. If a five-period moving average is used,
the forecast for period 6 is 11000 + 2000 + 3000 + 4000 + 50002 , 5 = 3000 .
It does not look very accurate since the forecast is lagging actual demand by a
large amount. However, if a three-month moving average is used, the forecast is
(3000 + 4000 + 5000) , 3 = 4000. Not perfect, but somewhat better. The point
is that a moving average always lags a trend, and the more periods included in
the average, the greater the lag will be.
On the other hand, if there is no trend but actual demand fluctuates considerably due to random variation, a moving average based on a few periods reacts to the
fluctuation rather than forecasts the average. Consider the following demand history:
Period
Demand
1
2000
2
5000
3
3000
4
1000
5
4000
The demand has no trend and is random. If a five-month moving average is
used, the forecast for the next month is 3000. This reflects all the values. If a twomonth average is taken, the forecasts for the third, fourth, fifth, and sixth months are:
Forecast for third month
Forecast for fourth month
Forecast for fifth month
Forecast for sixth month
=
=
=
=
12000
15000
13000
11000
+
+
+
+
50002
30002
10002
40002
,
,
,
,
2
2
2
2
=
=
=
=
3500
4000
2000
2500
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Forecasting
With a two-month moving average the forecast reacts very quickly to the latest
demand and thus is not stable.
Moving averages are best used for forecasting products with stable demand
where there is little trend or seasonality. Moving averages are also useful to filter out
random fluctuations. This has some common sense since periods of high demand are
often followed by periods of low demand.
One drawback to using moving averages is the need to retain several periods of
history for each item to be forecast. This will require a great deal of computer storage
or clerical effort. Also, the calculations are cumbersome. A common forecasting
technique, called exponential smoothing, gives the same results as a moving average
but without the need to retain as much data and with easier calculations.
Exponential Smoothing
It is not necessary to keep months of history to get a moving average because the previously calculated forecast has already allowed for this history. Therefore, the forecast can be based on the old calculated forecast and the new data.
Using the data in Figure 8.4, suppose an average of the demand of the last six
months (80 units) is used to forecast January demand. If at the end of January, actual
demand is 90 units, we must drop July’s demand and pick up January’s demand to
determine the new forecast. However, if an average of the old forecast (80) and the
actual demand for January (90) is taken, the new forecast for February is 85 units.
This formula puts as much weight on the most recent month as on the old forecast
(all previous months). If this does not seem suitable, less weight could be put on the
latest actual demand and more weight on the old forecast. Perhaps putting only 10%
of the weight on the latest month’s demand and 90% of the weight on the old forecast
would be better. In that case,
February forecast = 0.11902 + 0.91802 = 81
Notice that this forecast did not rise as much as our previous calculation in
which the old forecast and the latest actual demand were given the same weight. One
advantage to exponential smoothing is that the new data can be given any weight
wanted.
The weight given to latest actual demand is called a smoothing constant and is
represented by the Greek letter alpha (α). It is always expressed as a decimal from 0
to 1.0.
In general, the formula for calculating the new forecast is:
New forecast = 121latest demand2 + 11 - 21previous forecast2
EXAMPLE PROBLEM
The old forecast for May was 220, and the actual demand for May was 190. If alpha
(α) is 0.15, calculate the forecast for June. If June demand turns out to be 218, calculate the forecast for July.
Chapter 8
Answer
June forecast = 10.15211902 + 11 - 0.15212202 = 215.5
July forecast = 10.15212182 + 10.8521215.52 = 215.9
Exponential smoothing provides a routine method for regularly updating item
forecasts. It works quite well when dealing with stable items. Generally, it has been
found satisfactory for short-range forecasting. It is not satisfactory where the demand
is low or intermittent.
Exponential smoothing will detect trends, although the forecast will lag actual
demand if a definite trend exists. Figure 8.5 shows a graph of the exponentially
smoothed forecast lagging the actual demand where a positive trend exists. Notice
the forecast with the larger follows actual demand more closely.
If a trend exists, it is possible to use a slightly more complex formula called double exponential smoothing. This technique uses the same principles but notes
whether each successive value of the forecast is moving up or down on a trend line.
Double exponential smoothing is beyond the scope of this text.
A problem exists in selecting the “best” alpha factor. If a low factor such as 0.1
is used, the old forecast will be heavily weighted, and changing trends will not be
picked up as quickly as might be desired. If a larger factor such as 0.4 is used, the forecast will react sharply to changes in demand and will be erratic if there is a sizable
random fluctuation. A good way to get the best alpha factor is to use computer
140
130
Actual
Demand
120
DEMAND
228
110
100
Forecast: α = .1
90
Forecast: α = .3
80
1
2
3
4
5
PERIODS
Figure 8.5 Exponential forecast where trend exists.
6
7
8
229
Forecasting
simulation. Using past actual demand, forecasts are made with different alpha factors
to see which one best suits the historical demand pattern for particular products.
SEASONALITY
Many products have a seasonal or periodic demand pattern: skis, lawnmowers,
bathing suits, and Christmas tree lights are examples. Less obvious are products
whose demand varies by the time of day, week, or month. Examples of these might be
electric power usage during the day or grocery shopping during the week. Power
usage peaks between 4:00 P.M. and 7:00 P.M. and supermarkets are most busy toward
the end of the week or before certain holidays.
Seasonal Index
A useful indication of the degree of seasonal variation for a product is the seasonal
index. This index is an estimate of how much the demand during the season will be
above or below the average demand for the product. For example, swimsuit demand
might average 100 per month, but in July the average is 175, and in September it’s 35.
The index for July demand would be 1.75, and for September it would be 0.35.
The formula for the seasonal index is:
Seasonal index =
period average demand
average demand for all periods
The period can be daily, weekly, monthly, or quarterly depending on the basis
for the seasonality of demand.
The average demand for all periods is a value that averages out seasonality.
This is called the deseasonalized demand. The previous equation can be rewritten as:
Season index =
period average demand
deseasonalized demand
EXAMPLE PROBLEM
A product that is seasonally based on quarterly demand and the demand for the past
three years is shown in Figure 8.6. There is no trend, but there is definite seasonality.
Average quarterly demand is 100 units. Figure 8.6 also shows a graph of actual seasonal demand and average quarterly demand. The average demand shown is the historical average demand for all periods. Remember we forecast average demand, not
seasonal demand.
Chapter 8
Year
1
122
130
132
128
1
2
3
Average
Quarter
3
81
73
71
75
2
108
100
98
102
4
90
96
99
95
Total
401
399
400
400
140
130
Average Demand
120
DEMAND
230
110
100
90
80
Actual Demand
70
60
1
2
3
4
5
6
7
QUARTERS
8
9
10
11
12
Figure 8.6 Seasonal sales history.
Answer
The seasonal indices can now be calculated as follows:
128
100
102
=
100
75
=
100
95
=
100
Total of seasonal indices
Seasonal index =
= 1.28 1quarter 12
= 1.02 1quarter 22
= 0.75 1quarter 32
= 0.95 1quarter 42
= 4.00
Note that the total of all the seasonal indices equals the number of periods. This is a
good way to check whether the calculations are correct.
Seasonal Forecasts
The equation for developing seasonal indices is also used to forecast seasonal
demand. If a company forecasts average demand for all periods, the seasonal indices
can be used to calculate the seasonal forecasts. Changing the equation around we get:
Seasonal demand = 1seasonal index21deseasonalized demand2
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Forecasting
EXAMPLE PROBLEM
The company in the previous problem forecasts an annual demand next year of 420
units. Calculate the forecast for quarterly sales.
Answer
Forecast average quarterly demand =
Expected quarter demand
Expected first-quarter demand
Expected second-quarter demand
Expected third-quarter demand
Expected fourth-quarter demand
Total forecast demand
=
=
=
=
=
420
= 105 units
4
1seasonal index21forecast quarterly demand2
1.28 * 105 = 134.4 units
1.02 * 105 = 107.1 units
0.75 * 105 = 78.75 units
0.95 * 105 = 99.75 units
= 420 units
Deseasonalized Demand
Forecasts do not consider random variation. They are made for average demand, and
seasonal demand is calculated from the average using seasonal indices. Figure 8.7 shows
both actual demand and forecast average demand. The forecast average demand is also
the deseasonalized demand. Historical data are of actual seasonal demand, and they
must be deseasonalized before they can be used to develop a forecast of average demand.
25
DEMAND
20
Forecast Demand
15
10
Actual Demand
5
0
1
2
3
4
5
6
7
QUARTERS
Figure 8.7 Seasonal demand.
8
9
10
11
12
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Also, if comparisons are made between sales in different periods, they are
meaningless unless deseasonalized data are used. For example, a company selling
tennis rackets finds demand is usually largest in the summer. However, some people
play indoor tennis, so there is demand in the winter months as well. If demand in
January was 5200 units and in June was 24,000 units, how could January demand be
compared to June demand to see which was the better demand month? If there is
seasonality, comparison of actual demand would be meaningless. Deseasonalized
data are needed to make a comparison.
The equation to calculate deseasonalized demand is derived from the previous
seasonal equation and is as follows:
Deseasonalized demand =
actual seasonal demand
seasonal index
EXAMPLE PROBLEM
A company selling tennis rackets has a January demand of 5200 units and a July demand
of 24,000 units. If the seasonal indices for January were 0.5 and for June were 2.5, calculate the deseasonalized January and July demand. How do the two months compare?
Answer
Deseasonalized January demand = 5200 , 0.5 = 10,400 units
Deseasonalized June demand = 24,000 , 2.5 = 9600 units
June and January demand can now be compared. On a deseasonalized basis, January
demand is greater than June demand.
Deseasonalized data must be used for forecasting. Forecasts are made for average demand, and the forecast for seasonal demand is calculated from the average
demand using the appropriate season index.
The rules for forecasting with seasonality are:
• Only use deseasonalized data to forecast.
• Forecast deseasonalized demand (base forecast), not seasonal demand.
• Calculate the seasonal forecast by applying the seasonal index to the base forecast.
EXAMPLE PROBLEM
A company uses exponential smoothing to forecast demand for its products. For
April, the deseasonalized forecast was 1000, and the actual seasonal demand was
1250 units. The seasonal index for April is 1.2 and for May is 0.7. If α is 0.1, calculate:
a. The deseasonalized actual demand for April.
b. The deseasonalized May forecast.
c. The seasonal forecast for May.
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Forecasting
Answer
1250
= 1042
1.2
(latest actual) (1 )
(previous forecast)
= 0.1110422 + 0.9110002 = 1004
a. Deseasonalized actual demand for April =
b. Deseasonalized May forecast
c. Seasonalized May forecast
(seasonal index)
(deseasonalized forecast)
= 0.7110042 = 703
TRACKING THE FORECAST
As noted in the discussion on the principles of forecasting, forecasts are usually
wrong. There are several reasons for this, some of which are related to human
involvement and others to the behavior of the economy. If there were a method of
determining how good a forecast is, forecasting methods could be improved and better estimates could be made accounting for the error. There is no point in continuing
with a plan based on poor forecast data. We need to track the forecast. Tracking the
forecast is the process of comparing actual demand with the forecast.
Forecast Error
Forecast error is the difference between actual demand and forecast demand. Error
can occur in two ways: bias and random variation.
Bias. Cumulative actual demand may not be the same as forecast. Consider the
data in Figure 8.8. Actual demand varies from forecast, and over the six-month
period, cumulative demand is 120 units greater than expected.
Bias exists when the cumulative actual demand varies from the cumulative forecast. This means the forecast average demand has been wrong. In the example in
Figure 8.8, the forecast average demand was 100, but the actual average demand was
720 , 6 = 120 units . Figure 8.9 shows a graph of cumulative forecast and actual
demand.
Bias is a systematic error in which the actual demand is consistently above or
below the forecast demand. When bias exists, the forecast should be changed to
improve its accuracy.
The purpose of tracking the forecast is to be able to react to forecast error by
planning around it or by reducing it. When an unacceptably large error or bias is
observed, it should be investigated to determine its cause.
Often there are exceptional one-time reasons for error. Examples are machine
breakdown, customer shutdown, large one-time orders, and sales promotions.
These reasons relate to the discussion on collection and preparation of data and the
Chapter 8
Month
Forecast
Actual
Monthly
Cumulative
Monthly
Cumulative
1
100
100
110
110
2
100
200
125
235
3
100
300
120
355
4
100
400
125
480
5
100
500
130
610
6
100
600
110
720
Total
600
600
720
720
Figure 8.8 Forecast and actual sales with bias.
800
Forecast
Actual
700
600
DEMAND
234
500
400
300
200
100
0
0
1
2
3
MONTH
Figure 8.9 Forecast and actual demand with bias.
4
5
6
235
Forecasting
need to record the circumstances relating to the data. On these occasions, the
demand history must be adjusted to consider the exceptional circumstances.
Errors can also occur because of timing. For example, an early or late winter
will affect the timing of demand for snow shovels although the cumulative demand
will be the same.
Tracking cumulative demand will confirm timing errors or exceptional one-time
events. The following example illustrates this. Note that in April the cumulative
demand is back in a normal range.
Cumulative
Month
Forecast
Actual
Forecast
January
100
95
100
February
100
110
200
March*
100
155
300
April
100
45
400
May
100
90
500
*Customer foresaw a possible strike and stockpiled.
Cumulative
Actual
95
205
360
405
495
Random variation. In a given period, actual demand will vary about the average
demand. The variability will depend upon the demand pattern of the product. Some
products will have a stable demand, and the variation will not be large. Others will be
unstable and will have a large variation.
Consider the data in Figure 8.10, showing forecast and actual demand.
Notice there is much random variation, but the average error is zero. This shows
Month
Forecast
Actual
Variation
(error)
1
100
105
5
2
100
94
–6
3
100
98
–2
4
100
104
4
5
100
103
3
6
100
96
–4
Total
600
600
0
Figure 8.10 Forecast and actual sales without bias.
Chapter 8
120
115
110
DEMAND
236
Forecast
105
100
95
Actual
90
85
80
1
2
3
4
5
6
MONTHS
Figure 8.11 Forecast and actual sales without bias.
that the average forecast was correct and there was no bias. The data are plotted in
Figure 8.11.
Mean Absolute Deviation
Forecast error must be measured before it can be used to revise the forecast or to
help in planning. There are several ways to measure error, but one commonly used is
mean absolute deviation (MAD).
Consider the data on variability in Figure 8.10. Although the total error (variation) is zero, there is still considerable variation each month. Total error would be
useless to measure the variation. One way to measure the variability is to calculate
the total error ignoring the plus and minus signs and take the average. This is mean
absolute deviation:
• mean implies an average,
• absolute means without reference to plus and minus,
• deviation refers to the error:
MAD =
sum of absolute deviations
number of observations
237
Forecasting
EXAMPLE PROBLEM
Given the data shown in Figure 8.10, calculate the mean absolute deviation.
Answer
Sum of absolute deviations = 5 + 6 + 2 + 4 + 3 + 4 = 24
24
MAD =
= 4
6
Normal distribution. The mean absolute deviation measures the difference
(error) between actual demand and forecast. Usually, actual demand is close to the
forecast but sometimes is not. A graph of the number of times (frequency) actual
demand is of a particular value produces a bell-shaped curve. This distribution is
called a normal distribution and is shown in Figure 8.12. Chapter 11 gives a more
detailed discussion of normal distributions and their characteristics.
There are two important characteristics to normal curves: the central tendency,
or average, and the dispersion, or spread, of the distribution. In Figure 8.12, the central tendency is the forecast. The dispersion, the fatness or thinness of the normal
curve, is measured by the standard deviation. The greater the dispersion, the larger
the standard deviation. The mean absolute deviation is an approximation of the standard deviation and is used because it is easy to calculate and apply.
From statistics we know that the error will be within:
1 MAD of the average about 60% of the time
2 MAD of the average about 90% of the time
3 MAD of the average about 98% of the time
Uses of mean absolute deviation.
Some of the most important follow.
Mean absolute deviation has several uses.
Tracking signal. Bias exists when cumulative actual demand varies from forecast. The
problem is in guessing whether the variance is due to random variation or bias. If the
variation is due to random variation, the error will correct itself, and nothing should
1%
1%
4%
−3
15%
−2
30%
−1
30%
0
15%
1
MEAN ABSOLUTE DEVIATIONS
Figure 8.12 Normal distribution curve.
4%
2
3
238
Chapter 8
be done to adjust the forecast. However, if the error is due to bias, the forecast should
be corrected. Using the mean absolute deviation, we can make some judgment about
the reasonableness of the error. Under normal circumstances, the actual period
demand will be within 3 MAD of the average 98% of the time. If actual period
demand varies from the forecast by more than 3 MAD, we can be about 98% sure
that the forecast is in error.
A tracking signal can be used to monitor the quality of the forecast. There are several procedures used, but one of the simpler is based on a comparison of the cumulative
sum of the forecast errors to the mean absolute deviation. Following is the equation:
Tracking signal =
algebraic sum of forecast errors
MAD
EXAMPLE PROBLEM
The forecast is 100 units a week. The actual demand for the past six weeks has been
105, 110, 103, 105, 107, and 115. If MAD is 7.5, calculate the sum of the forecast error
and the tracking signal.
Answer
Sum of forecast error = 5 + 10 + 3 + 5 + 7 + 15 = 45
Tracking signal = 45 , 7.5 = 6
EXAMPLE PROBLEM
A company uses a trigger of ±4 to decide whether a forecast should be reviewed.
Given the following history, determine in which period the forecast should be
reviewed. MAD for the item is 2.
Period
Forecast
Actual
1
100
96
2
100
98
3
100
104
4
100
110
Deviation
Cumulative
Deviation
Tracking
Signal
5
2.5
239
Forecasting
Answer
Period
Forecast
Actual
Deviation
Cumulative
Deviation
Tracking
Signal
5
2.5
1
100
96
–4
1
0.5
2
100
98
–2
–1
– 0.5
3
100
104
4
3
1.5
4
100
110
10
13
6.5
The forecast should be reviewed in period 4.
Contingency planning. Suppose a forecast is made that demand for door slammers
will be 100 units and that capacity for making them is 110 units. Mean absolute deviation of actual demand about the forecast historically has been calculated at 10 units.
This means there is a 60% chance that actual demand will be between 90 and 110
units and a 40% chance that they will not. With this information, manufacturing management might be able to devise a contingency plan to cope with the possible extra
demand.
Safety stock. The data can be used as a basis for setting safety stock. This will be discussed in detail in Chapter 11.
P/D Ratio
Because of the inherent error in forecasts, companies that rely on them can run into
a variety of problems. For example, the wrong material may be bought and perhaps
processed into the wrong goods. A more reliable way of producing what is really
needed is the use of the P/D ratio.
“P,” or production lead time, is the stacked lead time for a product. It includes
time for purchasing and arrival of raw materials, manufacturing, assembly, delivery,
and sometimes the design of the product. Figure 1.1. on page 4 shows various times in
different types of industries and is reproduced in Figure 8.13.
240
Chapter 8
Delivery Lead Time
DESIGN
PURCHASE
MANUFACTURE
ASSEMBLE
SHIP
ENGINEER-TOORDER
SHIP
MAKE-TOORDER
Delivery Lead Time
INVENTORY
MANUFACTURE
ASSEMBLE
Delivery Lead Time
MANUFACTURE
ASSEMBLE
SHIP
ASSEMBLETO-ORDER
INVENTORY
SHIP
MAKE-TOSTOCK
INVENTORY
Delivery Lead Time
MANUFACTURE
ASSEMBLE
Figure 8.13 Manufacturing lead time and strategy.
“D,” or demand lead time, is the customer’s lead time. It is the time from when
a customer places an order until the goods are delivered. It can be very short, as in a
make-to-stock environment, or very long, as in an engineer-to-order company.
The traditional way to guard against inherent error in forecasting is to include
safety stock in inventory. There is an added expense to the extra inventory carried
“just in case.” One other way is to make more accurate predictions. There are five
ways to move in this direction.
1. Reduce P time. The longer the P time, the more chance there is for error.
Ideally, P will be less than D.
2. Force a match between P and D. Moving in this direction can be done in two
ways:
a. Make the customer’s D time equal to your P time. This is common with custom products when the manufacturer makes the product according to the
customer’s specification.
b. Sell what you forecast. This will happen while you control the market. One
good example is the automobile market. It is common to offer special
inducements toward the end of the automotive year in order to sell what the
manufacturers have predicted.
3. Simplify the product line. The more variety in the product line, the more room
for error.
4. Standardize products and processes. This means that “customization” occurs
close to final assembly. The basic components are identical, or similar, for all
components. Figure 8.14 shows this graphically.
5. Forecast more accurately. Make forecasts using a well-thought-out, wellcontrolled process.
241
Forecasting
Figure 8.14 Mushroom design.
End Product - Variable
Standard Ingredients
SUMMARY
Forecasting is an inexact science that is, nonetheless, an invaluable tool if the following are kept in mind:
• Forecasts should be tracked.
• There should be a measure of reasonableness of error.
• When actual demand exceeds the reasonableness of error, an investigation
should be made to discover the cause of the error.
• If there is no apparent cause of error, the method of forecasting should be
reviewed to see if there is a better way to forecast.
There are several methods used to forecast, including qualitative, intrinsic, and
extrinsic methods.
KEY TERMS
Demand management 217
Order processing 217
Trend 219
Seasonality 220
Random variation 220
Stable 220
Dynamic 220
Qualitative techniques 223
Extrinsic forecasting
techniques 223
Economic indicators 223
Intrinsic forecasting
techniques 224
Average demand 225
Moving averages 227
Exponential smoothing 227
Smoothing constant 227
Seasonal index 229
Deseasonalized
demand 229
Forecast error 233
Bias 233
Mean absolute deviation
(MAD) 236
Normal distribution 237
Tracking signal 238
Production lead
time 239
Demand lead time 240
242
Chapter 8
QUESTIONS
1. What is demand management? What functions does it include?
2. Why must we forecast?
3. What factors influence the demand for a firm’s products?
4. Describe the purpose of forecasting for strategic business planning, production planning, and master production scheduling.
5. The text describes three characteristics of demand. Name and describe each.
6. Describe trend, seasonality, random variation, and cycle as applied to forecasting.
7. The text discusses four principles of forecasting. Name and describe each.
8. Name and describe the three principles of data collection.
9. Describe the characteristics and differences between qualitative, extrinsic, and intrinsic
forecasting techniques.
10. Describe and give the advantages and disadvantages of (a) moving averages and
(b) exponential smoothing.
11. What is a seasonal index? How is it calculated?
12. What is meant by the term deseasonalized demand?
13. What is meant by the term tracking the forecast? In which two ways can forecasts go
wrong?
14. What is bias error in forecasting? What are some of the causes?
15. What is random variation?
16. What is the mean absolute deviation (MAD)? Why is it useful in forecasting?
17. What action should be taken when unacceptable error is found in tracking a forecast?
18. What is the P/D ratio? How may it be improved?
19. What might it mean if a forecasting method has no bias yet has a large MAD?
PROBLEMS
8.1
Over the past three months, the demand for a product has been 255, 219, and 231.
Calculate the three-month moving average forecast for month 4. If the actual demand in
month 4 is 228, calculate the forecast for month 5.
Answer.
235, 226
243
Forecasting
8.2
Given the following data, calculate the three-month moving average forecasts for
months 4, 5, 6, and 7.
Month
Actual Demand
1
60
2
70
3
40
4
50
5
70
6
65
Forecast
7
8.3
Monthly demand over the past ten months is given in what follows.
a. Graph the demand.
b. What is your best guess for the demand for month 11?
c. Using a three-month moving average, calculate the forecasts for months 4, 5, 6, 7, 8,
9, 10, and 11.
Month
Actual Demand
1
102
2
91
3
95
4
105
5
94
6
100
7
109
8
92
9
101
10
98
11
Forecast
244
Chapter 8
8.4 If the forecast for February was 122 and actual demand was 135, what would be the forecast for March if the smoothing constant (α) is 0.15? Use exponential smoothing for
your calculation.
Forecast = 123.95 = 124
Answer.
8.5
If the old forecast is 100 and the latest actual demand is 85, what is the exponentially
smoothed forecast for the next period? Alpha is 0.2.
8.6
Using exponential smoothing, calculate the forecasts for months 2, 3, 4, 5, and 6. The
smoothing constant is 0.2, and the old forecast for month 1 is 245.
Month
Actual Demand
1
260
2
230
3
225
4
245
5
250
6
Forecast Demand
245
Forecasting
8.7
Using exponential smoothing, calculate the forecasts for the same months as in problem
8.3c. The old average for month 3 was 96 and = 0.2. What is the difference between
the two forecasts for month 11?
Month
Actual Demand
1
102
2
91
3
95
4
105
5
94
6
100
7
109
8
92
9
101
10
98
11
Forecast
246
Chapter 8
8.8
Weekly demand for an item averaged 100 units over the past year. Actual demand for
the next eight weeks is shown in what follows:
a. Plot the data on graph paper.
b. Letting = 0.25, calculate the smoothed forecast for each week.
c. Comment on how well the forecast is tracking actual demand. Is it lagging or leading
actual demand?
Week
Actual Demand
Forecast
1
103
100
2
112
3
113
4
120
5
126
6
128
7
138
8
141
9
8.9
If the average demand for the first quarter was 140 and the average demand for all
quarters was 175, what is the seasonal index for the first quarter?
Answer.
Seasonal index = 0.80
8.10 Using the data in problem 8.9, if the forecast for next year is 800, calculate the forecast
for first quarterly demand next year.
Answer.
Forecast for first quarter = 160
8.11 The average demand for January has been 90, and the average annual demand has been
1800. Calculate the seasonal index for January. If the company forecasts annual demand
next year at 2000 units, what is the forecast for January next year?
247
Forecasting
8.12 Given the following average demand for each month, calculate the seasonal indices for
each month.
Month
Average Demand
January
30
February
50
March
85
April
110
May
125
June
245
July
255
August
135
September
100
October
90
November
50
December
30
Total
Seasonal Index
248
Chapter 8
8.13 Using the data in problem 8.12 and the seasonal indices you have calculated, calculate
expected monthly demand if the annual forecast is 2000 units.
Month
Seasonal Index
Forecast
January
February
March
April
May
June
July
August
September
October
November
December
8.14 If the actual demand for April was 1440 units and the seasonal index was 2.5, what would
be the deseasonalized April demand?
Deseasonalized demand = 576 units
Answer.
8.15 Calculate the deseasonalized demands for the following:
Quarter
Actual Demand
Seasonal Index
1
130
0.62
2
170
1.04
3
375
1.82
4
90
0.52
Total
Deseasonalized Demand
249
Forecasting
8.16 The old deseasonalized forecast is 100 units, = 0.25 and the actual demand for the
last month was 150 units. If the seasonal index for the last month is 1.2 and the next
month is 0.8, calculate:
a. The deseasonalized actual demand for the last month.
b. The deseasonalized forecast for next month using exponential smoothing.
c. The forecast of actual demand for the next month.
Answer.
a. Deseasonalized last month’s demand = 125
b. Deseasonalized forecast for next month = 106
c. Forecast of seasonal demand = 85
8.17 The Fast Track Ski Shoppe sells ski goggles during the four months of the ski season.
Average demand follows:
a. Calculate the deseasonalized sales and the seasonal index for each of the four months.
b. If next year’s demand is forecast at 1200 pairs of goggles, what will be the forecast
sales for each month?
Month
Average Past Demand
December
300
January
400
February
200
March
150
Seasonal Index
Forecast Demand Next Year
Total
8.18 Given the following forecast and actual demand, calculate the mean absolute deviation.
Period
Forecast
Actual Demand
1
110
85
2
110
105
3
110
120
4
110
100
5
110
90
Total
Answer.
MAD = 14
Absolute Deviation
250
Chapter 8
8.19 For the following data, calculate the mean absolute deviation.
Period
Forecast
Actual Demand
1
100
105
2
105
95
3
110
90
4
115
135
5
120
105
6
125
120
Total
675
650
Absolute Deviation
8.20 A company uses a tracking signal trigger of 4 to decide whether a forecast should be
reviewed. Given the following history, determine in which period the forecast should be
reviewed. MAD for the item is 15. Is there any previous indication that the forecast
should be reviewed?
Period
Forecast
Actual
1
100
110
2
105
90
3
110
85
4
115
110
5
120
105
6
125
95
Deviation
Cumulative Deviation
Tracking Signal
Forecasting
251
NORTHCUTT BIKES: THE FORECASTING PROBLEM
Jan Northcutt, owner of Northcutt Bikes, started business in 1995 when she noticed
the quality of bikes she purchased for sale in her bike shop declining while the prices
went up. She also found it more difficult to obtain the features she wanted on ordered
bikes without waiting for months. Her frustration turned to a determination to build
her own bikes to her particular customer specification.
She began by buying all the necessary parts (frames, seats, tires, etc.) and
assembling them in a rented garage using two helpers. As the word spread about
her shop’s responsiveness to options, delivery, and quality, however, the individual
customer base grew to include other bike shops in the area. As her business grew
and demanded more of her attention, she soon found it necessary to sell the bike
shop itself and concentrate on the production of bikes from a fairly large leased
factory space.
As the business continued to grow, she backward integrated more and more
processes into her operation, so that now she purchases less than 50% of the component value of the manufactured bikes. This not only improves her control of production quality but also helps her control the costs of production and makes the final
product more cost attractive to her customers.
The Current Situation
Jan considers herself a hands-on manager and has typically used her intuition and her
knowledge of the market to anticipate production needs. Since one of her founding
principles was rapid and reliable delivery to customer specification, she felt she
needed to begin production of the basic parts for each particular style of bike well in
advance of demand. In that way she could have the basic frame, wheels, and standard
accessories started in production prior to the recognition of actual demand, leaving
only the optional add-ons to assemble once the order came in. Her turnaround time
for an order of less than half the industry average is considered a major strategic
advantage, and she feels it is vital for her to maintain or even improve on response
time if she is to maintain her successful operation.
As the customer base has grown, however, the number of customers Jan
knows personally has shrunk significantly as a percentage of the total customer
base for Northcutt Bikes, and many of these new customers are expecting or even
demanding very short response times, as that is what attracted them to Northcutt
Bikes in the first place. This condition, in addition to the volatility of overall
demand, has put a strain on capacity planning. She finds that at times there is a lot
of idle time (adding significantly to costs), whereas at other times the demand
exceeds capacity and hurts customer response time. The production facility has
therefore turned to trying to project demand for certain models and actually building a finished goods inventory of those models. This has not proven to be too
252
Chapter 8
satisfactory, as it has actually hurt costs and some response times. Reasons include
the following:
• The finished goods inventory is often not the “right” inventory, meaning shortages for some goods and excessive inventory of others. This condition both
hurts responsiveness and increases inventory costs.
• Often to help maintain responsiveness, inventory is withdrawn from finished
goods and reworked, adding to product cost.
• Reworking inventory uses valuable capacity for other customer orders, again
resulting in poorer response times and/or increased costs due to expediting.
Existing production orders and rework orders are both competing for vital
equipment and resources during times of high demand, and scheduling has
become a nightmare.
The inventory problem has grown to the point that additional storage space is
needed, and that is a cost that Jan would like to avoid if possible.
Another problem Jan faces is the volatility of demand for bikes. Since she is
worried about unproductive idle time and yet does not wish to lay off her workers
during times of low demand, she has allowed them to continue to work steadily and
build finished goods. This makes the problem of building the “right” finished goods
even more important, especially given the tight availability of storage space.
Past Demand
The following shows the monthly demand for one major product line: the standard
26-inch 10-speed street bike. Although it is only one of Jan’s products, it is representative of most of the major product lines currently being produced by Northcutt
Bikes. If Jan can find a way to use this data to more constructively understand her
demand, she feels she can probably use the same methodologies to project demand
for other major product families. Such knowledge can allow her, she feels, to plan
more effectively and continue to be responsive while still controlling costs.
ACTUAL DEMAND
Month
2008
2009
2010
2011
January
February
March
April
May
June
July
August
September
October
November
December
437
605
722
893
901
1311
1055
975
822
893
599
608
712
732
829
992
1148
1552
927
1284
1118
737
983
872
613
984
812
1218
1187
1430
1392
1481
940
994
807
527
701
1291
1162
1088
1497
1781
1843
839
1273
912
996
792
Forecasting
253
Tasks
1. Plot the data and describe what you see. What does it mean and how would you
use the information from the plot to help you develop a forecast?
2. Use at least two different methodologies to develop as accurate a forecast for
the demand as possible. Use each of those methods to project the next four
months demand.
3. Which method from question 2 is “better”? How do you know that?
4. How, if at all, could we use Jan’s knowledge of the market to improve the fore-
cast? Would it be better to forecast in quarterly increments instead of monthly?
Why or why not?
5. Are there other possible approaches that might improve Jan’s operation and
situation? What would they be and how could they help?
6. Has Jan’s operation grown too large for her to control well? Why or why not?
What would you suggest she do? What additional information would you suggest she look for to help her situation?
9
Inventory Fundamentals
INTRODUCTION
Inventories are materials and supplies that a business or institution carries either for
sale or to provide inputs or supplies to the production process. All businesses and
institutions require inventories. Often they are a substantial part of total assets.
Financially, inventories are very important to manufacturing companies. On the
balance sheet, they usually represent from 20% to 60% of total assets. As inventories
are used, their value is converted into cash, which improves cash flow and return on
investment. There is a cost for carrying inventories, which increases operating costs
and decreases profits. Good inventory management is essential.
Inventory management is responsible for planning and controlling inventory
from the raw material stage to the customer. Since inventory either results from production or supports it, the two cannot be managed separately and, therefore, must be
coordinated. Inventory must be considered at each of the planning levels and is thus
part of production planning, master production scheduling, and material requirements planning. Production planning is concerned with overall inventory, master
planning with end items, and material requirements planning with component parts
and raw material.
254
Inventory Fundamentals
255
AGGREGATE INVENTORY MANAGEMENT
Aggregate inventory management deals with managing inventories according to their
classification (raw material, work-in-process, and finished goods) and the function
they perform rather than at the individual item level. It is financially oriented and is
concerned with the costs and benefits of carrying the different classifications of inventories. As such, aggregate inventory management involves:
•
•
•
•
•
Flow and kinds of inventory needed.
Supply and demand patterns.
Functions that inventories perform.
Objectives of inventory management.
Costs associated with inventories.
ITEM INVENTORY MANAGEMENT
Inventory is not only managed at the aggregate level but also at the item level.
Management must establish decision rules about inventory items so the staff responsible for inventory control can do their job effectively. These rules include the following:
•
•
•
•
Which individual inventory items are most important.
How individual items are to be controlled.
How much to order at one time.
When to place an order.
This chapter will study aggregate inventory management and some factors
influencing inventory management decisions, which include:
•
•
•
•
•
Types of inventory based on the flow of material.
Supply and demand patterns.
Functions performed by inventory.
Objectives of inventory management.
Inventory costs.
Finally, this chapter will conclude with a study of the first two decisions, deciding the importance of individual end items and how they are controlled. Subsequent
chapters will discuss the question of how much stock to order at one time and when to
place orders.
256
Chapter 9
INVENTORY AND THE FLOW OF MATERIAL
There are many ways to classify inventories. One often-used classification is related to
the flow of materials into, through, and out of a manufacturing organization, as shown
in Figure 9.1.
• Raw materials. These are purchased items received that have not entered the
production process. They include purchased materials, component parts, and
subassemblies.
• Work-in-process (WIP). Raw materials that have entered the manufacturing
process and are being worked on or waiting to be worked on.
• Finished goods. The finished products of the production process that are ready
to be sold as completed items. They may be held at a factory or central warehouse or at various points in the distribution system.
SUPPLIER
SUPPLIER
SUPPLIER
RAW MATERIALS
PURCHASED PARTS
AND
MATERIALS
WORK-IN-PROCESS
FINISHED GOODS
WAREHOUSE
WAREHOUSE
WAREHOUSE
CUSTOMER
DEMAND
CUSTOMER
DEMAND
CUSTOMER
DEMAND
Figure 9.1 Inventories and the flow of materials.
Inventory Fundamentals
257
• Distribution inventories. Finished goods located in the distribution system.
• Maintenance, repair, and operational supplies (MROs). Items used in production that do not become part of the product. These include hand tools, spare
parts, lubricants, and cleaning supplies.
Classification of an item into a particular inventory depends on the production
environment. For instance, sheet steel or tires are finished goods to the supplier but
are raw materials and component parts to the car manufacturer.
SUPPLY AND DEMAND PATTERNS
If supply met demand exactly, there would be little need for inventory. Goods could
be made at the same rate as demand, and no inventory would build up. For this situation to exist, demand must be predictable, stable, and relatively constant over a long
time period.
If this is so, manufacturing can produce goods on a line-flow basis, matching
production to demand. Using this system, raw materials are fed to production as
required, work flow from one workstation to another is balanced so little work-inprocess inventory is required, and goods are delivered to the customer at the rate the
customer needs them. Flow manufacturing systems were discussed in Chapter 1.
Because the variety of products they can make is so limited, demand has to be large
enough to justify economically setting up the system. These systems are characteristic
of just-in-time manufacturing and will be discussed in Chapter 15.
Demand for most products is neither sufficient nor constant enough to warrant
setting up a line-flow system, and these products are usually made in lots or batches.
Workstations are organized by function—for example, all machine tools in one area,
all welding in another, and assembly in another. Work moves in lots from one workstation to another as required by the routing. By the nature of the system, inventory
will build up in raw materials, work-in-process, and finished goods.
FUNCTIONS OF INVENTORIES
In batch manufacturing, the basic purpose of inventories is to decouple supply and
demand. Inventory serves as a buffer between:
•
•
•
•
•
Supply and demand.
Customer demand and finished goods.
Finished goods and component availability.
Requirements for an operation and the output from the preceding operation.
Parts and materials to begin production and the suppliers of materials.
Based on this, inventories can be classified according to the function they perform.
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Anticipation Inventory
Anticipation inventories are built up in anticipation of future demand. For example,
they are created ahead of a peak selling season, a promotion program, vacation shutdown, or possibly the threat of a strike. They are built up to help level production and
to reduce the costs of changing production rates.
Fluctuation Inventory (Safety Stock)
Fluctuation inventory is held to cover random unpredictable fluctuations in supply
and demand or lead time. If demand or lead time is greater than forecast, a stockout
will occur. Safety stock is carried to protect against this possibility. Its purpose is to
prevent disruptions in manufacturing or deliveries to customers. Safety stock is also
called buffer stock or reserve stock.
Lot-Size Inventory
Items purchased or manufactured in quantities greater than needed immediately create lot-size inventories. This is to take advantage of quantity discounts; to reduce
shipping, clerical, and setup costs; and in cases where it is impossible to make or purchase items at the same rate that they will be used or sold. Lot-size inventory is sometimes called cycle stock. It is the portion of inventory that depletes gradually as customers’ orders come in and is replenished cyclically when suppliers’ orders are
received.
Transportation Inventory
Transportation inventories exist because of the time needed to move goods from one
location to another such as from a plant to a distribution center or a customer. They
are sometimes called pipeline or movement inventories. The average amount of
inventory in transit is:
I =
tA
365
where I is the average annual inventory in transit, t is transit time in days, and A is
annual demand. Notice that the transit inventory does not depend upon the shipment
size but on the transit time and the annual demand. The only way to reduce the inventory in transit, and its cost, is to reduce the transit time.
EXAMPLE PROBLEM
Delivery of goods from a supplier is in transit for 10 days. If the annual demand is
5200 units, what is the average annual inventory in transit?
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Inventory Fundamentals
Answer
I =
10 * 5200
= 142.5 units
365
The problem can be solved in the same way using dollars instead of units.
Hedge Inventory
Some products such as minerals and commodities—for example, grains or animal
products—are traded on a worldwide market. The price for these products fluctuates
according to world supply and demand. If buyers expect prices to rise, they can purchase hedge inventory when prices are low. Hedging is complex and beyond the scope
of this text.
Maintenance, Repair, and Operating Supplies (MROs)
MROs are items used to support general operations and maintenance but that do not
become directly part of a product. They include maintenance supplies, spare parts,
and consumables such as cleaning compounds, lubricants, pencils, and erasers.
OBJECTIVES OF INVENTORY MANAGEMENT
A firm wishing to maximize profit will have at least the following objectives:
• Maximum customer service.
• Low-cost plant operation.
• Minimum inventory investment.
Customer Service
In broad terms, customer service is the ability of a company to satisfy the needs of
customers. In inventory management, the term is used to describe the availability of
items when needed and is a measure of inventory management effectiveness. The
customer can be a purchaser, a distributor, another plant in the organization, or the
workstation where the next operation is to be performed.
There are many different ways to measure customer service, each with its
strengths and weaknesses, but there is no one best measurement. Some measures are
percentage of orders shipped on schedule, percentage of line items shipped on schedule, and order-days out of stock.
Inventories help to maximize customer service by protecting against uncertainty. If we could forecast exactly what customers want and when, we could plan to
meet demand with no uncertainty. However, demand and the lead time to get an item
are often uncertain, possibly resulting in stockouts and customer dissatisfaction. For
these reasons, it may be necessary to carry extra inventory to protect against uncertainty. This inventory is called safety stock and will be discussed in Chapter 11.
Chapter 9
Operating Efficiency
Inventories help make a manufacturing operation more productive in four ways:
1. Inventories allow operations with different rates of production to operate separately and more economically. If two or more operations in a sequence have different rates of output and are to be operated efficiently, inventories must build
up between them.
2. Chapter 2 discussed production planning for seasonal products in which
demand is nonuniform throughout the year. One strategy discussed was to level
production and build anticipation inventory for sale in the peak periods. This
would result in the following:
• Lower overtime costs.
• Lower hiring and firing costs.
• Lower training costs.
• Lower subcontracting costs.
• Lower capacity required.
By leveling production, manufacturing can continually produce an amount
equal to the average demand. The advantage of this strategy is that the costs of
changing production levels are avoided. Figure 9.2 shows this strategy.
3. Inventories allow manufacturing to run longer production runs, which result in
the following:
• Lower setup costs per item. The cost to make a lot or batch depends upon the
setup costs and the run costs. The setup costs are fixed, but the run costs vary
with the number produced. If larger lots are run, the setup costs are
absorbed over a larger number, and the average (unit) cost is lower.
• An increase in production capacity due to production resources being used at a
greater portion of the time for processing as opposed to setup. Time on a work
Figure 9.2 Operation
leveling.
DEMAND
260
Demand
Production
J
F
M
A
M
J
TIME
J
A
S
O
N
D
Inventory Fundamentals
261
center is taken up by setup and by run-time. Output occurs only when an
item is being worked on and not when setup is taking place. If larger quantities are produced at one time, there are fewer setups required to produce a
given annual output, and thus more time is available for producing goods.
This is most important with bottleneck resources. Time lost on setup on
these resources is lost throughput (total production) and lost capacity.
4. Inventories allow manufacturing to purchase in larger quantities, which results
in lower ordering costs per unit and quantity discounts.
But all of this is at a price. The problem is to balance inventory investment with
the following:
1. Customer service. The lower the inventory, the higher the likelihood of a stockout and the lower the level of customer service. The higher the inventory level,
the higher customer service will be.
2. Costs associated with changing production levels. Excess equipment capacity,
overtime, hiring, training, and layoff costs will all be higher if production fluctuates with demand.
3. Cost of placing orders. Lower inventories can be achieved by ordering smaller
quantities more often, but this practice results in higher annual ordering costs.
4. Transportation costs. Goods moved in small quantities cost more to move per unit
than those moved in large quantities. However, moving large lots implies higher
inventory.
If inventory is carried, there has to be a benefit that exceeds the costs of carrying that inventory. Someone once said that the only good reason for carrying inventory beyond current needs is if it costs less to carry it than not. This being so, we
should turn our attention to the costs associated with inventory.
INVENTORY COSTS
The following costs are used for inventory management decisions:
•
•
•
•
•
Item cost.
Carrying costs.
Ordering costs.
Stockout costs.
Capacity-associated costs.
Item Cost
Item cost is the price paid for a purchased item, which consists of the cost of the item
and any other direct costs associated in getting the item into the plant. These could
include such things as transportation, custom duties, and insurance. The inclusive
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cost is often called the landed price. For an item manufactured in-house, the cost
includes direct material, direct labor, and factory overhead. These costs can usually
be obtained from either purchasing or accounting.
Carrying Costs
Carrying costs include all expenses incurred by the firm because of the volume of
inventory carried. As inventory increases, so do these costs. They can be broken down
into three categories:
1. Capital costs. Money invested in inventory is not available for other uses and as
such represents a lost opportunity cost. The minimum cost would be the interest lost by not investing the money at the prevailing interest rate, and it may be
much higher depending on investment opportunities for the firm.
2. Storage costs. Storing inventory requires space, workers, and equipment. As
inventory increases, so do these costs.
3. Risk costs. The risks in carrying inventory are:
a. Obsolescence; loss of product value resulting from a model or style change
or technological development.
b. Damage; inventory damaged while being held or moved.
c. Pilferage; goods lost, strayed, or stolen.
d. Deterioration; inventory that rots or dissipates in storage or whose shelf life
is limited.
What does it cost to carry inventory? Actual figures vary from industry to industry and company to company. Capital costs may vary depending upon interest rates,
the credit rating of the firm, and the opportunities the firm may have for investment.
Storage costs vary with location and type of storage needed. Risk costs can be very
low or can be close to 100% of the value of the item for perishable goods. The carrying cost is usually defined as a percentage of the dollar value of inventory per unit of
time (usually one year). Textbooks tend to use a figure of 20–30% in manufacturing
industries. This is realistic in many cases but not with all products. For example, the
possibility of obsolescence with fad or fashion items is high, and the cost of carrying
such items is greater.
EXAMPLE PROBLEM
A company carries an average annual inventory of $2,000,000. If it estimates the cost
of capital is 10%, storage costs are 7%, and risk costs are 6%, what does it cost per
year to carry this inventory?
Inventory Fundamentals
263
Answer
Total cost of carrying inventory = 10% + 7% + 6% = 23%
Annual cost of carrying inventory = 0.23 * $2,000,000 = $460,000
Ordering Costs
Ordering costs are those costs associated with placing an order either with the factory
or a supplier. The cost of placing an order does not depend upon the quantity
ordered. Whether a lot of 10 or 100 is ordered, the costs associated with placing the
order are essentially the same. However, the annual cost of ordering depends upon
the number of orders placed in a year.
Ordering costs in a factory include the following:
• Production control costs. The annual cost and effort expended in production
control depends on the number of orders placed, not on the quantity ordered.
The fewer orders per year, the less cost. The costs incurred are those of issuing
and closing orders, scheduling, loading, dispatching, and expediting.
• Setup and teardown costs. Every time an order is issued, work centers have to set up
to run the order and tear down the setup at the end of the run. These costs do not
depend upon the quantity ordered but on the number of orders placed per year.
• Lost capacity cost. Every time an order is placed at a work center, the time taken
to set up is lost as productive output time. This represents a loss of capacity and
is directly related to the number of orders placed. It is particularly important
and costly with bottleneck work centers.
• Purchase order cost. Every time a purchase order is placed, costs are incurred to
place the order. These costs include order preparation, follow-up, expediting,
receiving, authorizing payment, and the accounting cost of receiving and paying
the invoice.
The annual cost of ordering depends upon the number of orders placed in a
year. This can be reduced by ordering more at one time, resulting in the placing of
fewer orders. However, this drives up the inventory level and the annual cost of carrying inventory.
EXAMPLE PROBLEM
Given the following annual costs, calculate the average cost of placing one order.
Production control salaries = $60,000
Supplies and operating expenses for production control department = $15,000
Cost of setting up work centers for an order = $120
Orders placed each year = 2000
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Chapter 9
Answer
fixed costs
+ variable cost
number of orders
$60,000 + $15,000
+ $120 = $157.50
=
2000
Average cost =
Stockout Costs
If demand during the lead time exceeds forecast, we can expect a stockout. A stockout can potentially be expensive because of back-order costs, lost sales, and possibly
lost customers. Stockouts can be reduced by carrying extra inventory to protect
against those times when the demand during lead time is greater than forecast.
Capacity-Associated Costs
When output levels must be changed, there may be costs for overtime, hiring, training, extra shifts, and layoffs. These capacity-associated costs can be avoided by leveling production, that is, by producing items in slack periods for sale in peak periods.
However, this builds inventory in the slack periods.
EXAMPLE PROBLEM
A company makes and sells a seasonal product. Based on a sales forecast of 2000,
3000, 6000, and 5000 per quarter, calculate a level production plan, quarterly ending
inventory, and average quarterly inventory.
If inventory carrying costs are $3 per unit per quarter, what is the annual cost of
carrying inventory? Opening and ending inventories are zero.
Answer
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Total
Forecast Demand
2000
3000
6000
5000
16,000
Production
4000
4000
4000
4000
16,000
2000
3000
1000
0
Average Inventory
1000
2500
2000
500
Inventory Cost (dollars)
3000
7500
6000
1500
Ending Inventory
0
18,000
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Inventory Fundamentals
FINANCIAL STATEMENTS AND INVENTORY
The two major financial statements are the balance sheet and the income statement. The balance sheet shows assets, liabilities, and owners’ equity. The income
statement shows the revenues made and the expenses incurred in achieving that
revenue.
Balance Sheet
An asset is something that has value and is expected to benefit the future operation
of the business. An asset may be tangible, such as cash, inventory, machinery, and
buildings, or may be intangible, such as accounts receivable or a patent.
Liabilities are obligations or amounts owed by a company. Accounts payable,
wages payable, and long-term debt are examples of liabilities.
Owners’ equity is the difference between assets and liabilities. After all the liabilities are paid, it represents what is left for the owners of the business. Owners’
equity is created either by the owners investing money in the business or through the
operation of the business when it earns a profit. It is decreased when owners take
money out of the business or when the business loses money.
The accounting equation. The relationship between assets, liabilities, and owners’ equity is expressed by the balance sheet equation:
Assets = liabilities + owners’ equity
This is a basic accounting equation. Given two of the values, the third can
always be found.
EXAMPLE PROBLEM
a. If the owners’ equity is $1,000 and liabilities are $800, what are the assets?
b. If the assets are $1,000 and liabilities are $600, what is the owners’ equity?
Answer
a. Assets = Liabilities + owners’ equity
Assets = $800 + $1,000 = $1,800
b. Owners’ equity = assets - liabilities
= $1,000 - $600 = $400
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Chapter 9
Balance sheet. The balance sheet is usually shown with the assets on the left side
and the liabilities and owners’ equity on the right side as follows.
Assets
Cash
Accounts receivable
Inventory
Fixed assets
Total assets
$100,000
$300,000
$500,000
$1,000,000
$1,900,000
Liabilities
Notes payable
Accounts payable
Long-term debt
Total liabilities
Owners’ equity
Capital
Retained earnings
Total liabilities and
owners’ equity
$5,000
$20,000
$500,000
$525,000
$1,000,000
$375,000
$1,900,000
Capital is the amount of money the owners have invested in the company.
Retained earnings are increased by the revenues a company makes and
decreased by the expenses incurred. The summary of revenues and expenses is shown
on the income statement.
Income Statement
Income (profit). The primary purpose of a business is to increase the owners’ equity
by making a profit. For this reason owners’ equity is broken down into a series of
accounts, called revenue accounts, which show what increased owners’ equity, and
expense accounts, which show what decreased owners’ equity.
Income = revenue - expenses
Revenue comes from the sale of goods or services. Payment is sometimes immediate in the form of cash, but often is made as a promise to pay at a later date, called
an account receivable.
Expenses are the costs incurred in the process of making revenue. They are
usually categorized into the cost of goods sold and general and administrative
expenses.
Cost of goods sold are costs that are incurred to make the product. They include
direct labor, direct material, and factory overhead. Factory overhead is all other factory costs except direct labor and direct material.
General and administrative expenses include all other costs in running
a business. Examples of these are advertising, insurance, property taxes, and
wages and benefits other than direct material, direct labor, and factory overhead costs.
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Inventory Fundamentals
The following is an example of an income statement.
Revenue
Cost of goods sold
Direct labor
Direct material
Factory overhead
Gross margin (profit)
General and administrative expenses
Net income (profit)
$1,000,000
$200,000
400,000
200,000
$800,000
$200,000
$100,000
$100,000
EXAMPLE PROBLEM
Given the following data, calculate the gross margin and the net income.
Revenue
Direct labor
Direct material
Factory overhead
General and administrative expenses
=
=
=
=
=
$1,500,000
$ 300,000
$ 500,000
$ 400,000
$ 150,000
How much would profits increase if, through better materials management, material
costs are reduced by $50,000?
Revenue
Cost of goods sold
Direct labor
Direct material
Overhead
Gross margin (gross profit)
General and administrative expenses
Net income (profit)
$1,500,000
$300,000
500,000
400,000
$1,200,000
$ 300,000
$ 150,000
$ 150,000
If material costs are reduced by $50,000, income increases by $50,000. Materials management can have a direct impact on the bottom line—net income.
Cash Flow Analysis
When inventory is purchased as raw material, it is recorded as an asset. When it
enters production, it is recorded as work-in-process (WIP) inventory, and as it is
processed, its value increases by the amount of direct labor applied to it and the
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Chapter 9
overhead attributed to its processing. The material is said to absorb overhead. When
the goods are ready for sale, they do not become revenue until they are sold.
However, the expenses incurred in producing the goods must be paid for. This raises
another financial issue: Businesses must have the cash to pay their bills. Cash is generated by sales, and the flow of cash into a business must be sufficient to pay bills as
they become due. Businesses develop financial statements showing the cash flows
into and out of the business. Any shortfall of cash must be provided for, perhaps by
borrowing or in some other way. This type of analysis is called cash flow analysis.
Financial Inventory Performance Measures
From a financial point of view, inventory is an asset and represents money that is tied
up and cannot be used for other purposes. As we saw previously in this chapter,
inventory has a carrying cost—the costs of capital, storage, and risk. Finance wants as
little inventory as possible and needs some measure of the level of inventory. Total
inventory investment is one measure, but in itself does not relate to sales. Two measures that do relate to sales are the inventory turns ratio and days of supply.
Inventory turns. Ideally, a manufacturer carries no inventory. This is impractical,
since inventory is needed to support manufacturing and often to supply customers.
How much inventory is enough? There is no one answer. A convenient measure of
how effectively inventories are being used is the inventory turns ratio:
Inventory turns =
annual cost of goods sold
average inventory in dollars
The calculation of average inventory can be complicated and is a subject for
cost accounting. In this text it will be taken as a given.
For example, if the annual cost of goods sold is $1 million and the average
inventory is $500,000, then
Inventory turns =
$1,000,000
= 2
$500,000
What does this mean? At the very least, it means that with $500,000 of inventory
a company is able to generate $1 million in sales. If, through better materials management, the firm is able to increase its turns ratio to 10, the same sales are generated
with only $100,000 of average inventory. If the annual cost of carrying inventory is
25% of the inventory value, the reduction of $400,000 in inventory results in a cost
reduction (and profit increase) of $100,000.
EXAMPLE PROBLEM
a. What will be the inventory turns ratio if the annual cost of goods sold is $24 million
a year and the average inventory is $6 million?
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Inventory Fundamentals
Answer
Inventory turns =
=
annual cost of goods sold
average inventory in dollars
24,000,000
= 4
6,000,000
b. What would be the reduction in inventory if inventory turns were increased to
12 times per year?
Answer
Average inventory =
=
annual cost of goods sold
inventory turns
24,000,000
12
= $2,000,000
Reduction in inventory = 6,000,000 - 2,000,000 = $4,000,000
c. If the cost of carrying inventory is 25% of the average inventory, what will the
savings be?
Answer
Reduction in inventory = $4,000,000
Savings = $4,000,000 * 0.25 = $1,000,000
Days of supply Days of supply is a measure of the equivalent number of days of
inventory on hand, based on usage. The equation to calculate the days of supply is
Days of supply =
inventory on hand
average daily usage
EXAMPLE PROBLEM
A company has 9000 units on hand and the annual usage is 48,000 units. There are
240 working days in the year. What is the days of supply?
Answer
Average daily savings =
Days of supply =
48,000
= 200 units
240
inventory on hand
9000
=
= 45 days
average daily usage
200
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Chapter 9
Methods of Evaluating Inventory
There are four methods accounting uses to “cost” inventory: first in first out, last in first
out, average cost, and standard cost. Each has implications for the value placed on inventory. If there is little change in the price of an item, any of the four ways will produce
about the same results. However, in rising or falling prices, there can be a pronounced
difference. There is no relationship with the actual physical movement of actual items in
any of the methods. Whatever method is used is only to account for usage.
First in first out (FIFO). This method assumes that the oldest (first) item in stock
is sold first. In rising prices, replacement is at a higher price than the assumed cost.
This method does not reflect current prices, and replacement will be understated.
The reverse is true in a falling price market.
Last in first out (LIFO). This method assumes the newest (last) item in stock is the
first sold. In rising prices, replacement is at the current price. In a falling price market
existing inventory is overvalued. However, the company is left with an inventory that
may be grossly understated in value.
Average cost. This method assumes an average of all prices paid for the article.
The problem with this method in changing prices (rising or falling) is that the cost
used is not related to the actual cost.
Standard cost. This method uses cost determined before production begins. The
cost includes direct material, direct labor, and overhead. Any difference between the
standard cost and actual cost is stated as a variance.
ABC INVENTORY CONTROL
Control of inventory is exercised by controlling individual items, which is called stockkeeping units (SKUs). In controlling inventory, four questions must be answered:
1. What is the importance of the inventory item?
2. How are they to be controlled?
3. How much should be ordered at one time?
4. When should an order be placed?
The ABC inventory classification system answers the first two questions by
determining the importance of items and thus allowing different levels of control
based on the relative importance of items.
Most companies carry a large number of items in stock. To have better control at a reasonable cost, it is helpful to classify the items according to their importance. Usually this is based on annual dollar usage, but other criteria may be used.
The ABC principle is based on the observation that a small number of items
often dominate the results achieved in any situation. This observation was first made
Inventory Fundamentals
271
by an Italian economist, Vilfredo Pareto, and is called Pareto’s law. As applied to
inventories, it is usually found that the relationship between the percentage of items
and the percentage of annual dollar usage follows a pattern in which three groups can
be defined:
Group A
Group B
Group C
About 20% of the items account for about 80% of the dollar
usage.
About 30% of the items account for about 15% of the dollar
usage.
About 50% of the items account for about 5% of the dollar
usage.
The percentages are approximate and should not be taken as absolute. This
type of distribution can be used to help control inventory.
Steps in Making an ABC Analysis
1. Establish the item characteristics that influence the results of inventory management. This is usually annual dollar usage but may be other criteria, such as
scarcity of material.
2. Classify items into groups based on the established criteria.
3. Apply a degree of control in proportion to the importance of the group.
The factors affecting the importance of an item include annual dollar usage,
unit cost, and scarcity of material. For simplicity, only annual dollar usage is used in
this text. The procedure for classifying by annual dollar usage is as follows:
1. Determine the annual usage for each item.
2. Multiply the annual usage of each item by its cost to get its total annual dollar
usage.
3. List the items according to their annual dollar usage.
4. Calculate the cumulative annual dollar usage and the cumulative percentage of
items.
5. Examine the annual usage distribution and group the items into A, B, and C
groups based on percentage of annual usage.
EXAMPLE PROBLEM
A company manufactures a line of ten items. The usage and unit cost are shown in
the following table, along with the annual dollar usage. The latter is obtained by multiplying the unit usage by the unit cost.
a. Calculate the annual dollar usage for each item.
b. List the items according to their annual dollar usage.
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Chapter 9
c. Calculate the cumulative annual dollar usage and the cumulative percentage of
items.
d. Group items into an A, B, C classification.
Answer
a. Calculate the annual dollar usage for each item.
Part Number
Unit Usage
Unit Cost $
Annual $ Usage
1
1100
2
2200
2
600
40
24,000
3
100
4
400
4
1300
1
1300
5
100
60
6000
6
10
25
250
7
100
2
200
8
1500
2
3000
9
200
2
400
10
500
1
500
Total
5510
$38,250
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Inventory Fundamentals
b. b, c, and d.
Part
Number
Annual
$ Usage
Cumulative
$ Usage
Cumulative
% $ Usage
Cumulative
% of Items
Class
2
24,000
24,000
62.75
10
A
5
6000
30,000
78.43
20
A
8
3000
33,000
86.27
30
B
1
2200
35,200
92.03
40
B
4
1300
36,500
95.42
50
B
10
500
37,000
96.73
60
C
9
400
37,400
97.78
70
C
3
400
37,800
98.82
80
C
6
250
38,050
99.48
90
C
7
200
38,250
100.00
100
C
The percentage of value and the percentage of items is often shown as a graph,
as in Figure 9.3.
Control Based on ABC Classification
Using the ABC approach, there are two general rules to follow:
1. Have plenty of low-value items. C items represent about 50% of the items but
account for only about 5% percent of the total inventory value. Carrying extra
stock of C items adds little to the total value of the inventory. C items are really
only important if there is a shortage of one of them—when they become
extremely important—so a supply should always be on hand. For example,
order a year’s supply at a time and carry plenty of safety stock. That way there is
only once a year when a stockout is even possible.
2. Use the money and control effort saved to reduce the inventory of high-value items.
A items represent about 20% of the items and account for about 80% of the
value. They are extremely important and deserve the tightest control and the
most frequent review.
Chapter 9
Figure 9.3 ABC curve:
percentage of value
versus percentage of
items.
100
PERCENTAGE OF VALUE
274
80
60
40
20
A
0
0
B
C
20
40
60
80
PERCENTAGE OF ITEMS
100
Different controls used with different classifications might be the following:
• A items: high priority. Tight control including complete accurate records, regular
and frequent review by management, frequent review of demand forecasts, and
close follow-up and expediting to reduce lead time.
• B items: medium priority. Normal controls with good records, regular attention,
and normal processing.
• C items: lowest priority. Simplest possible controls—make sure there are plenty.
Simple or no records; perhaps use a two-bin system or periodic review system.
Order large quantities and carry safety stock.
SUMMARY
There are benefits as well as costs to having inventory. The problem is to balance the
cost of carrying inventory with the following:
• Customer service. The lower the inventory level, the higher the likelihood of a
stockout and the potential cost of back orders, lost sales, and lost customers.
The higher the inventory level, the higher the level of customer service.
• Operating efficiency. Inventories decouple one operation from another and allow
manufacturing to operate more efficiently. They allow leveling production and
avoid the costs of changing production levels. Carrying inventory allows longer
production runs and reduces the number of setups. Finally, inventories let manufacturing purchase in larger quantities. The ABC inventory classification system
prioritizes individual items so that inventory and costs can be better controlled.
275
Inventory Fundamentals
• Cost of placing orders. Inventory can be reduced by ordering less each time an
order is placed. However, this increases the annual cost of ordering.
• Transportation and handling costs. The more often goods have to be moved and
the smaller the quantities moved, the greater the transportation and material
handling costs.
Inventory management is influenced by several factors:
• The classification of the inventory, whether raw material, work-in-process, or
finished goods.
• The functions that inventory serves: anticipation, fluctuation, lot size, or
transportation.
• Supply and demand patterns.
• The costs associated with carrying (or not carrying) inventory.
Besides managing inventory at the aggregate level, it must also be managed at
the item level. Management needs to establish decision rules about inventory items
so inventory control personnel can do their job effectively.
KEY TERMS
Raw materials 256
Work-in-process (WIP) 256
Finished goods 256
Distribution inventories 257
Maintenance, repair, and
operational supplies
(MROs) 257
Anticipation inventories 258
Fluctuation inventory 258
Safety stock 258
Lot-size inventories 258
Cycle stock 258
Transportation inventories 258
Pipeline 258
Movement inventories 258
Hedge inventory 259
Item cost 261
Landed price 262
Carrying costs 262
Stockout 264
Capacity-associated costs 264
Asset 265
Liabilities 265
Owners’ equity 265
Accounting equation 265
Balance sheet 266
Capital 266
Retained earnings 266
Income 266
Revenue 266
Expenses 266
Cost of goods sold 266
General and administrative
expenses 266
Inventory turns 268
Days of supply 269
First in first out (FIFO) 270
Last in first out (LIFO) 270
Average cost 270
Standard cost 270
ABC inventory 270
Pareto’s law 271
C items 273
A items 273
QUESTIONS
1. What are inventories? Why are they important to manufacturing companies?
2. What are the responsibilities of inventory management?
3. What is aggregate inventory management? With what is it concerned?
4. What are decision rules? Why are they necessary?
5. According to the flow of material, what are the four classifications of inventories?
6. Why is less inventory needed in a line-flow manufacturing system than in lot or batch
manufacturing?
276
Chapter 9
7. What is the basic purpose of inventories? In what four areas do they provide a buffer?
8. Describe the function and purpose of the following kinds of inventories:
a. Anticipation.
b. Fluctuation.
c. Lot size.
d. Transportation.
9. Describe how inventories influence each of the following:
a. Customer service.
b. Plant operations.
10. What are the five costs associated with inventories?
11. Name and describe the categories of inventory-carrying costs.
12. Name and describe the categories of ordering costs found in a factory.
13. What are stockout costs and capacity-associated costs? What is their relationship to
inventories?
14. What are the balance sheet equation and the income statement equation?
15. What is the purpose of cash flow analysis?
16. What do inventory turns and days of supply measure?
17. What is the basic premise of ABC analysis? What are the three steps in making an ABC
inventory analysis?
18. What are the five steps in the procedure for classifying inventory by annual dollar usage?
19. What is the difference between FIFO and LIFO?
PROBLEMS
9.1
9.2
9.3
9.4
9.5
If the transit time is 11 days and the annual demand for an item is 10,000 units, what is
the average annual inventory in transit?
Answer.
301.4 units
A company is using a carrier to deliver goods to a major customer. The annual demand
is $2,000,000, and the average transit time is 10 days. Another carrier promises to deliver
in 7 days. What is the reduction in transit inventory?
Given the following percentage costs of carrying inventory, calculate the annual carrying
cost if the average inventory is $1 million. Capital costs are 10%, storage costs are 6%,
and risk costs are 7%.
Answer.
$230,000
A florist carries an average inventory of $10,000 in cut flowers. The flowers require special storage and are highly perishable. The florist estimates capital costs at 10%, storage
costs at 25%, and risk costs at 50%. What is the annual carrying cost?
Annual purchasing salaries are $65,000, operating expenses for the purchasing department are $25,000, and inspecting and receiving costs are $25 per order. If the purchasing
department places 9,000 orders a year, what is the average cost of ordering? What is the
annual cost of ordering?
Average ordering cost = $35
Answer.
Annual cost = $315,000
277
Inventory Fundamentals
9.6
An importer operates a small warehouse that has the following annual costs. Wages for
purchasing are $45,000, purchasing expenses are $30,000, customs and brokerage costs
are $25 per order, the cost of financing the inventory is 8%, storage costs are 6%, and the
risk costs are 10%. The average inventory is $250,000, and 5000 orders are placed in a
year. What are the annual ordering and carrying costs?
9.7
A company manufactures and sells a seasonal product. Based on the sales forecast that
follows, calculate a level production plan, quarterly ending inventories, and average
quarterly inventories. Assume that the average quarterly inventory is the average of the
starting and ending inventory for the quarter. If inventory carrying costs are $3 per unit
per quarter, what is the annual cost of carrying this anticipation inventory? Opening and
ending inventories are zero.
Sales
Quarter 1
Quarter 2
Quarter 3
Quarter 4
1000
2000
3000
2000
Totals $
Production
Ending Inventory
Average Inventory
Inventory Cost
Answer.
9.8
Annual inventory costs = $6000
Given the following data, calculate a level production plan, quarterly ending inventory,
and average quarterly inventory. If inventory carrying costs are $6 per unit per quarter,
what is the annual carrying cost? Opening and ending inventory are zero.
Forecast Demand
Quarter 1
Quarter 2
Quarter 3
Quarter 4
5000
8000
8000
9000
Totals $
Production
Ending Inventory
Average Inventory
Inventory Cost
If the company always carries 100 units of safety stock, what is the annual cost of carrying it?
278
Chapter 9
9.9
Given the following data, calculate a level production plan, quarterly ending inventory,
and average quarterly inventory. If inventory carrying costs are $3 per unit per quarter,
what is the annual carrying cost? Opening and ending inventory are zero.
Quarter 1
Quarter 2
Quarter 3
Quarter 4
3000
4000
7000
6000
Forecast Demand
Totals $
Production
Ending Inventory
Average Inventory
Inventory Cost
9.10 If the assets are $2,000,000 and liabilities are $1,600,000, what is the owners’ equity?
Answer.
$400,000
9.11 If the liabilities are $4,000,000 and the owners’ equity is $1,200,000, what are the assets
worth?
9.12 Given the following data, calculate the gross margin and the net income.
Revenue = $3,000,000
Direct labor = $700,000
Direct material = $900,000
Factory overhead = $700,000
General and administrative expense = $300,000
Answer.
Gross margin = $700,000
Net income = $400,000
9.13 In question 9.12, how much would profit increase if the materials costs are reduced by
$200,000?
9.14 If the annual cost of goods sold is $12,000,000 and the average inventory is $2,500,000:
a. What is the inventory turns ratio?
b. What would be the reduction in average inventory if, through better materials management, inventory turns were increased to 10 times per year?
c. If the cost of carrying inventory is 20% of the average inventory, what is the annual
savings?
Answer.
a. 4.8
b. $1,300,000
c. $260,000
279
Inventory Fundamentals
9.15 If the annual cost of goods sold is $30,000,000 and the average inventory is $10,000,000:
a. What is the inventory turns ratio?
b. What would be the reduction in average inventory if, through better materials management, inventory turns were increased to 10 times per year?
c. If the cost of carrying inventory is 20% of the average inventory, what is the annual
savings?
9.16 A company has 600 units on hand and the annual usage is 7200 units. There are 240
working days in the year. What is the days of supply?
Answer.
20 days
9.17 Over the past year, a company has sold the following ten items. The following table
shows the annual sales in units and the cost of each item.
a. Calculate the annual dollar usage of each item.
b. List the items according to their total annual dollar usage.
c. Calculate the cumulative annual dollar usage and the cumulative percentage of items.
d. Group the items into A, B, and C groups based on percentage of annual dollar usage.
Part Number
Annual Unit Usage
Unit Cost $
1
21,000
1
2
5000
40
3
1600
3
4
12,000
1
5
1000
100
6
50
50
7
800
2
8
10,000
3
9
4000
1
10
5000
1
Answer.
A items
2, 5
B items
8, 1, 4
C items
10, 3, 9, 6, 7
Annual $ Usage
280
Chapter 9
9.18 Analyze the following data to produce an ABC classification based on annual dollar usage.
Part Number
Annual Unit Usage
Unit Cost $
1
200
10
2
15,000
4
3
60,000
6
4
15,000
15
5
1400
10
6
100
50
7
25,000
2
8
700
3
9
25,000
1
10
7500
1
Annual $ Usage
10
Order Quantities
INTRODUCTION
The objectives of inventory management are to provide the required level of customer
service and to reduce the sum of all costs involved. To achieve these objectives, two
basic questions must be answered:
1. How much should be ordered at one time?
2. When should an order be placed?
Management must establish decision rules to answer these questions so inventory
management personnel know when to order and how much. Lacking any better knowledge, decision rules are often made based on what seems reasonable. Unfortunately,
such rules do not always produce the best results.
This chapter will examine methods of answering the first question, and the next
chapter will deal with the second question. First, we must decide what we are ordering and controlling.
Stock-Keeping Unit (SKU)
Control is exercised through individual items in a particular inventory. These are
called stock-keeping units (SKUs). Two white shirts in the same inventory but of different sizes or styles would be two different SKUs. The same shirt in two different
inventories would be two different SKUs.
281
282
Chapter 10
Lot-Size Decision Rules
The eleventh edition of the APICS Dictionary defines a lot, or batch, as “a quantity produced together and sharing the same production costs and specifications.” Following
are some common decision rules for determining what lot size to order at one time.
Lot-for-lot. The lot-for-lot rule says to order exactly what is needed—no more—
no less. The order quantity changes whenever requirements change. This technique
requires time-phased information such as provided by a material requirements plan
or a master production schedule. Since items are ordered only when needed, this system creates no unused lot-size inventory. Because of this, it is the best method for
planning A items (see Chapter 9) and is also used in a just-in-time environment.
Fixed-order quantity. Fixed-order quantity rules specify the number of units to be
ordered each time an order is placed for an individual item or SKU. The quantity is
usually arbitrary, such as 200 units at a time. The advantage to this type of rule is that it
is easily understood. The disadvantage is that it does not minimize the costs involved.
A variation on the fixed-order quantity system is the min-max system. In this
system, an order is placed when the quantity available falls below the order point
(discussed in the next chapter). The quantity ordered is the difference between the
actual quantity available at the time of order and the maximum. For example, if the
order point is 100 units, the maximum is 300 units, and the quantity actually available
when the order is placed is 75, the order quantity is 225 units. If the quantity actually
available is 80 units, an order for 220 units is placed.
One commonly used method of calculating the quantity to order is the economicorder quantity, which is discussed in the next section.
Order n periods supply. Rather than ordering a fixed quantity, inventory management can order enough to satisfy future demand for a given period of time. The
question is how many periods should be covered? The answer is given later in this
chapter in the discussion on the period-order quantity system.
Costs
As shown in Chapter 9, the cost of ordering and the cost of carrying inventory both
depend on the quantity ordered. Ideally, the ordering decision rules used will minimize
the sum of these two costs. The best-known system is the economic-order quantity.
ECONOMIC-ORDER QUANTITY (EOQ)
Assumptions
The assumptions on which the EOQ is based are as follows:
1. Demand is relatively constant and is known.
2. The item is produced or purchased in lots or batches and not continuously.
283
Order Quantities
3. Order preparation costs and inventory-carrying costs are constant and known.
4. Replacement occurs all at once.
These assumptions are usually valid for finished goods whose demand is independent and fairly uniform. However, there are many situations where the assumptions are not valid and the EOQ concept is of no use. For instance, there is no reason
to calculate the EOQ for made-to-order items in which the customer specifies the
order quantity, the shelf life of the product is short, or the length of the run is limited
by tool life or raw material batch size. In material requirements planning, the lot-forlot decision rule is often used, but there are also several rules used that are variations
of the economic-order quantity.
Development of the EOQ Formula
Under the assumptions given, the quantity of an item in inventory decreases at a uniform rate. Suppose for a particular item that the order quantity is 200 units and the
usage rate is 100 units a week. Figure 10.1 shows how inventory would behave.
The vertical lines represent stock arriving all at once as the stock on hand
reaches zero. The quantity of units in inventory then increases instantaneously by Q,
the quantity ordered. This is an accurate representation of the arrival of purchased
parts or manufactured parts where all parts are received at once.
From the preceding,
Average lot size inventory =
order quantity
200
=
= 100 units
2
2
100 * 52
annual demand
=
order quantity
200
26 times per year
Number of orders per year =
EXAMPLE PROBLEM
The annual demand for an SKU is 10,075 units, and it is ordered in quantities of 650
units. Calculate the average inventory and the number of orders placed per year.
Answer
order quantity
650
=
= 325 units
2
2
10,075
annual demand
Number of orders per year =
=
= 15.5
order quantity
650
Average cycle inventory =
Chapter 10
UNITS IN STOCK
284
200
Q = Lot
Size
100
1
2
3
4
TIME (Weeks)
Figure 10.1 Inventory on hand over time.
Notice in the example problem that the number of orders per year is rounded
neither up nor down. It is an average figure, and the actual number of orders per year
will vary from year to year but will average to the calculated figure. In the example, 16
orders will be placed in one year and 15 in the second.
Relevant costs. The relevant costs are as follows:
• Annual cost of placing orders.
• Annual cost of carrying inventory.
As the order quantity increases, the average inventory and the annual cost of
carrying inventory increase, but the number of orders per year and the ordering cost
decrease. It is a bit like a seesaw where one cost can be reduced only at the expense of
increasing the other. The trick is to find the particular order quantity in which the
total cost of carrying inventory and the cost of ordering will be a minimum.
Let:
A
S
i
c
Q
=
=
=
=
=
annual usage in units
ordering cost in dollars per order
annual carrying cost rate as a decimal or a percentage
unit cost in dollars
order quantity in units
Then:
Annual ordering cost = number of orders * costs per order
A
=
* S
Q
Annual carrying cost = average inventory * cost of carrying 1 unit for 1 year
= average inventory * unit cost * carrying cost
Q
=
* c * i
2
285
Order Quantities
Total annual costs = annual ordering costs + annual carrying costs
=
Q
A
* S +
* c * i
Q
2
EXAMPLE PROBLEM
The annual demand is 10,000 units, the ordering cost is $30 per order, the carrying
cost is 20%, and the unit cost is $15. The order quantity is 600 units. Calculate:
a. Annual ordering cost
b. Annual carrying cost
c. Total annual cost
Answer
A = 10,000 units
S = $30
i = 0.20
c = $15
Q = 600 units
10,000
A
* S
=
* $30
= $500
Q
600
Q
600
b. annual carrying cost =
* c * i =
* $15 * 0.2 = $900
2
2
c. total annual cost
= $1400
a. annual ordering cost =
Ideally, the total cost will be a minimum. For any situation in which the annual
demand (A), the cost of ordering (S), and the cost of carrying inventory (i) are given,
the total cost will depend upon the order quantity (Q).
Trial-and-Error Method
Consider the following example:
A hardware supply distributor carries boxes of 3-inch bolts in stock. The annual
usage is 1000 boxes, and demand is relatively constant throughout the year. Ordering
costs are $20 per order, and the cost of carrying inventory is estimated to be 20%. The
cost per unit is $5.
286
Chapter 10
Let:
A = 1000 units
S = $20 per order
c = $5 per unit
i = 20% = 0.20
Then:
A
1000
* S =
* 20
Q
Q
Q
Q
* c * i =
* 5 * 0.20
Annual carrying cost =
2
2
Annual ordering cost =
Total annual cost = annual ordering cost + annual carrying cost
Figure 10.2 is a tabulation of the costs for different order quantities. The results
from the table in Figure 10.2 are represented on the graph in Figure 10.3.
Figures 10.2 and 10.3 show the following important facts:
1. There is an order quantity in which the sum of the ordering costs and carrying
costs is a minimum.
2. This EOQ occurs when the cost of ordering equals the cost of carrying.
3. The total cost varies little for a wide range of lot sizes about EOQ.
The last point is important for two reasons. First, it is usually difficult to determine accurately the cost of carrying inventory and the cost of ordering. Since the total
cost is relatively flat around the EOQ, it is not critical to have exact values. Good
approximations are sufficient. Second, parts are often ordered in convenient packages such as pallet loads, cases, or dozens, and it is adequate to pick the package
quantity closest to the EOQ.
Figure 10.2 Costs for
different lot sizes.
Order
Quantity
(Q)
50
100
150
200
250
300
350
400
Ordering
Costs
(AS/Q)
Carrying
Costs
(Qci/2)
Total
Cost
$400
200
133
100
80
67
57
50
$25
50
75
100
125
150
175
200
$425
250
208
200
205
217
232
250
287
Order Quantities
500
Total Cost
Ordering Cost
Carrying Cost
COST IN DOLLARS
400
300
200
100
0
50
100
150
200
250
300
350
400
LOT SIZE
Figure 10.3 Cost versus lot size.
Economic-Order Quantity Formula
The previous section showed that the EOQ occurred at an order quantity in which the
ordering costs equal the carrying costs. If these two costs are equal, the following formula can be derived:
Carrying costs = ordering costs
Qic
AS
=
2
Q
Solving for Q gives
Q2 =
Q =
2 AS
ic
2 AS
A ic
This value for the order quantity is the economic-order quantity. Using the formula to calculate the EOQ in the preceding example yields:
EOQ =
2AS
2 * 1000 * 20
=
= 200 units
A ic
A 0.20 * 5
How to Reduce Lot Size
The EOQ formula has four variables. The EOQ will increase as the annual demand (A)
and the cost of ordering (S) increase, and it will decrease as the cost of carrying inventory (i) and the unit cost (c) increase.
288
Chapter 10
The annual demand (A) is a condition of the marketplace and is beyond the
control of manufacturing. The cost of carrying inventory (i) is determined by the
product itself and the cost of money to the company. As such, it is beyond the control
of manufacturing.
The unit cost (c) is either the purchase cost of the SKU or the cost of manufacturing the item. Ideally, both costs should be as low as possible. In any event, as the
unit cost decreases, the EOQ increases.
The cost of ordering (S) is either the cost of placing a purchase order or the cost
of placing a manufacturing order. The cost of placing a manufacturing order is made
up from production control costs and setup costs. Anything that can be done to
reduce these costs reduces the EOQ.
Just-in-time manufacturing emphasizes reduction of setup time. There are several reasons why this is desirable, and the reduction of order quantities is one.
Chapter 15 discusses just-in-time manufacturing further.
VARIATIONS OF THE EOQ MODEL
There are several modifications that can be made to the basic EOQ model to fit particular circumstances. Two that are often used are the monetary unit lot-size model
and the noninstantaneous receipt model.
Monetary Unit Lot Size
The EOQ can be calculated in monetary units rather than physical units. The same
EOQ formula given in the preceding section can be used, but the annual usage
changes from units to dollars.
AD = annual usage in dollars
S = ordering costs in dollars
i carrying cost rate as a decimal or a percent
Because the annual usage is expressed in dollars, the unit cost is not needed in
the modified EOQ equation.
The EOQ in dollars is:
EOQ =
2 ADS
A i
EXAMPLE PROBLEM
An item has an annual demand of $5000, preparation costs of $20 per order, and a
carrying cost of 20%. What is the EOQ in dollars?
289
Order Quantities
AD = $5000
S = $20
i = 20% = 0.20
EOQ =
A
2 ADS
2 * 5000 * 20
=
= $1000
i
A
0.2
Noninstantaneous Receipt Model
In some cases when a replenishment order is made, the order is not all received at
one time. The most common reason for this is that the ordered material is being produced over an extended period of time, yet material is received for the order as it is
being produced. In this case the EOQ is modified to reflect the rate of production as
related to rate of demand:
EOQ =
2AS
A ic
a
p
b
p - d
Where
p the rate of production (in units per day) and
d the rate of demand (in units per day)
The units of time for p and d (shown above as units per day) can be any unit of time
as long as that unit of time is the same for both.
EXAMPLE PROBLEM
An item has a setup cost for production of $500 per order, and the inventory carrying
costs for the item is $12 per year. The demand for the item is constant at 11 units per
day. The production rate is 50 units per day while the item is being produced. What is
the noninstantaneous economic order quantity?
Annual demand 1A2 = 111 units per day2 * 1365 days per year2
4015 units per year
EOQ =
50
2140152 500
a
b
A
12
50 - 11
= 2334,583.311.32
= 655 units
290
Chapter 10
QUANTITY DISCOUNTS
When material is purchased, suppliers often give a discount on orders over a certain
size. This can be done because larger orders reduce the supplier’s costs; to get larger
orders, suppliers are willing to offer volume discounts. The buyer must decide
whether to accept the discount, and in doing so must consider the relevant costs:
• Purchase cost.
• Ordering costs.
• Carrying costs.
EXAMPLE PROBLEM
An item has an annual demand of 25,000 units, a unit cost of $10, an order preparation cost of $10, and a carrying cost of 20%. It is ordered on the basis of an EOQ, but
the supplier has offered a discount of 2% on orders of $10,000 or more. Should the
offer be accepted?
Answer
AD = 25,000 * $10 = $250,000
S = $10
i = 20%
2 * 250,000 * 10
EOQ =
= $5000
A
0.2
Discounted order quantity = $10,000 * 0.98 = $9,800
No discount
Unit Price
Lot Size
Average Lot-Size Inventory (Qc , 2)
Number of Orders per Year
Purchase Cost
Inventory-Carrying Cost (20%)
Order Preparation Cost ($10 each)
Total Cost
Discount lot size
$10
$5000
$2500
50
$9.80
$9800
$4900
25
$250,000
500
500
$251,000
$245,000
980
250
$246,230
From the preceding example problem, it can be said that taking the discount
results in the following:
• There is a saving in purchase cost.
• Ordering costs are reduced because fewer orders are placed since larger quantities are being ordered.
• Inventory-carrying costs rise because of the larger order quantity.
291
Order Quantities
The buyer must weigh the first two against the last and decide what to do. What
counts is the total cost. Depending on the figures, it may or may not be best to take
the discount.
ORDER QUANTITIES FOR FAMILIES OF PRODUCT
WHEN COSTS ARE NOT KNOWN
The EOQ formula depends upon the cost of ordering and the cost of carrying inventory. In practice, these costs are not necessarily known or easy to determine. However,
the formula can still be used to advantage when applied to a family of items.
For a family of items, the ordering costs and the carrying costs are generally the
same for each item. For instance, if we were ordering hardware items—nuts, bolts,
screws, nails, and so on—the carrying costs would be virtually the same (storage, capital, and risk costs) and the cost of placing an order with the supplier would be the
same for each item. In cases such as this, the cost of placing an order (S) is the same
for all items in the family as is cost of carrying inventory (i).
Now
Q =
2 ADS
A i
where A (annual demand) is in dollars.
Since S is the same for all the items and i is the same for all items, the ratio
2S , i must be the same for all items in the family. For convenience, let:
K =
2S
A i
Then
Q = K2AD
Also
Q =
Therefore
K2AD =
K =
AD
annual demand
=
orders per year
N
AD
N
2AD
N
Let’s see how this can be applied.
EXAMPLE PROBLEM
Suppose there were a family of items for which the decision rule was to order each
item four times a year. Since the cost of ordering (S) and the cost of carrying inventory (i) are not known, ordering four times a year is not based on an EOQ. Can we
come up with a better decision rule even if the EOQ cannot be calculated?
292
Chapter 10
Item
A
B
C
Annual
Usage
Orders
per Year
Present
Lot Size
4
4
4
12
$2500
100
36
$2636
$1318
$10,000
400
144
Average inventory 2AD
K =
$100
20
12
$132
AD
AN
25
5
3
33
The sum of all the lots is $2636. Since the average inventory is equal to half the
order quantity, the average inventory is $2636 , 2 = $1318.
Since this is a family of items where the preparation costs are the same and the
1
carrying costs are the same, the values for K = 12S , i2 冫2 should be the same for all
items. The preceding calculations show that they are not. The correct value for K is
not known, but a better value would be the average of all the values:
K =
=
g 2AD
gN
132
12
= 11
This value of K can be used to recalculate the order quantities for each item.
Item
A
B
C
Annual
Usage
Present
Orders
per Year
Present
Lot Size
2AD
New Lot
Size K2AD
$10,000
400
144
$10,544
4
4
4
12
$2500
100
36
$2636
$100
20
12
$132
$1100
220
132
$1452
Average inventory
Item A:
$1318
New Orders
per Year
N = AD>Q
9.09
1.82
1.09
12.00
$726
New lot size = K2AD = 11 * 100 = $1100
New orders per year =
AD
Q
=
10,000
= 9.09
1100
The average inventory has been reduced from $1318 to $726 while the number
of orders per year (12) remains the same. Thus, the total costs associated with inventory have been reduced.
293
Order Quantities
PERIOD-ORDER QUANTITY (POQ)
The economic-order quantity attempts to minimize the total cost of ordering and carrying inventory and is based on the assumption that demand is uniform. Often
demand is not uniform, particularly in material requirements planning, and using the
EOQ does not produce a minimum cost.
The period-order quantity lot-size rule is based on the same theory as the
economic-order quantity. It uses the EOQ formula to calculate an economic time
between orders. This is calculated by dividing the EOQ by the demand rate. This
produces a time interval for which orders are placed. Instead of ordering the same
quantity (EOQ), orders are placed to satisfy requirements for the calculated time
interval. The number of orders placed in a year is the same as for an economic-order
quantity, but the amount ordered each time varies. Thus, the ordering cost is the
same but, because the order quantities are determined by actual demand, the carrying cost is reduced.
Period-order quantity =
EOQ
average weekly usage
EXAMPLE PROBLEM
The EOQ for an item is 2800 units, and the annual usage is 52,000 units. What is the
period-order quantity?
Answer
Average weekly usage = 52,000 , 52 = 1000 per week
EOQ
Period-order quantity =
average weekly usage
2800
=
= 2.8 weeks
3 weeks
1000
When an order is placed it will cover the requirements for the next three weeks.
Notice the calculation is approximate. Precision is not important.
EXAMPLE PROBLEM
Given the following MRP record and an EOQ of 250 units, calculate the planned
order receipts using the economic-order quantity. Next, calculate the period-order
quantities and the planned order receipts. In both cases, calculate the ending inventory and the total inventory carried over the 10 weeks.
294
Chapter 10
Week
1
2
3
100
50
150
1
2
3
Net
Requirements
100
50
150
Planned Order
Receipt
250
Ending
Inventory
150
Net
Requirements
4
5
6
7
8
9
10
Total
75
200
55
80
150
30
890
5
6
7
8
9
10
Total
75
200
55
80
150
30
890
Planned Order
Receipt
Answer
EOQ = 250 units
Week
4
250
100
200
250
200
125
250
175
120
40
140
110
1360
5
6
7
8
9
10
Total
75
200
55
80
150
30
890
30
0
870
Period-order quantity:
Weekly average demand = 890 , 10 = 89 units
POQ = 250 , 89 = 2.81 : 3 weeks
Week
1
2
3
Net
Requirements
100
50
150
Planned Order
Receipt
300
Ending
Inventory
200
4
330
150
0
0
255
260
55
0
180
Notice in the example problem the total inventory is reduced from 1360 units to
870 units over the 10-week period.
Order Quantities
295
Practical Considerations When Using the EOQ
Lumpy demand. The EOQ assumes that demand is uniform and replenishment
occurs all at once. When this is not true, the EOQ will not produce the best results. It
is better to use the period-order quantity.
Anticipation inventory. Demand is not uniform, and stock must be built ahead. It
is better to plan a buildup of inventory based on capacity and future demand.
Minimum order. Some suppliers require a minimum order. This minimum may be
based on the total order rather than on individual items. Often these are C items
where the rule is to order plenty, not an EOQ.
Transportation inventory. As will be discussed in Chapter 13, carriers give rates
based on the amount shipped. A full load costs less per ton to ship than a part load.
This is similar to the price break given by suppliers for large quantities. The same
type of analysis can be used.
Multiples. Sometimes, order size is constrained by package size. For example, a
supplier may ship only in skid-load lots. In these cases, the unit used should be the
minimum package size.
Order quantities and just-in-time. As will be discussed in Chapter 15, JIT has a
profound effect on the amount of inventory to be produced at one time. The replenishment quantity of an item is adjusted to match the demand of the next operation in
the supply chain. This adjustment leads to smaller lot sizes and is often determined by
the frequency of shipments to a customer or the size of an easily moved container
rather than by calculation.
SUMMARY
The economic-order quantity is based on the assumption that demand is relatively
uniform. This is appropriate for some inventories, and the EOQ formula can be used
with reasonable results. One problem in using the EOQ formula is in determining the
cost of ordering and the cost of carrying inventory. Since the total cost curve is flat at
the bottom, good guesses very often will produce an order quantity that is economical. We have also seen that the EOQ concept can be used effectively with groups of
items when the costs of carrying and ordering are not known.
The two costs influenced by the order quantity are the cost of ordering and the
cost of carrying inventory. All methods of calculating order quantities attempt to
296
Chapter 10
minimize the sum of these two costs. The period-order quantity does this. It has the
advantage over the EOQ in that it is better for lumpy demand because it looks forward to see what is actually needed.
KEY TERMS
Stock-keeping units
(SKUs) 281
Lot-for-lot 282
Fixed-order quantity 282
Min-max system 282
Time between orders 293
QUESTIONS
1. What are the two basic questions in inventory management discussed in the text?
2. What are decision rules? What is their purpose?
3. What is an SKU?
4. What is the lot-for-lot decision rule? What is its advantage? Where would it be used?
5. What are the four assumptions on which economic-order quantities are based? For what
kind of items are these assumptions valid? When are they not?
6. Under the assumptions on which EOQs are based, what are the formulas for average lot
size and the number of orders per year?
7. What are the relevant costs associated with the two formulas? As the order quantities
increase, what happens to each cost? What is the objective in establishing a fixed-order
quantity?
8. Define each of the following in your own words and as a formula:
a. Annual ordering cost.
b. Annual carrying cost.
c. Total annual cost.
9. What is the economic-order quantity (EOQ) formula? Define each term and give the
units used. How do the units change when monetary units are used?
10. What are the relevant costs to be considered when deciding whether to take a quantity
discount? On what basis should the decision be made?
11. What is the period-order quantity? How is it established? When can it be used?
12. How do each of the following influence inventory decisions?
a. Lumpy demand.
b. Minimum orders.
c. Transportation costs.
d. Multiples.
13. A company working toward JIT will have smaller lot sizes when compared to using traditional methods. Discuss how this will affect the costs associated with inventory. What
are the controllable and the uncontrollable costs?
297
Order Quantities
PROBLEMS
10.1 An SKU costing $10 is ordered in quantities of 500 units, annual demand is 5200 units,
carrying costs are 20%, and the cost of placing an order is $50. Calculate the following:
a. Average inventory.
b. Number of orders placed per year.
c. Annual inventory-carrying cost.
d. Annual ordering cost.
e. Annual total cost.
Answer.
a. 250 units
b. 10.4 orders per year
c. Inventory-carrying cost = $500
d. Annual ordering cost = $520
e. Annual total cost = $1020
10.2 If the order quantity is increased to 1000 units, recalculate problems 10.1a to 10.1e and
compare the results.
10.3 A company decides to establish an EOQ for an item. The annual demand is 400,000
units, each costing $8, ordering costs are $32 per order, and inventory-carrying costs are
20%. Calculate the following:
a. The EOQ in units.
b. Number of orders per year.
c. Cost of ordering, cost of carrying inventory, and total cost.
Answer.
a. 4000 units
b. Number of orders per year = 100
c. Annual cost of ordering = $3200
Annual cost of carrying = $3200
Annual total cost = $6400
10.4 A company wishes to establish an EOQ for an item for which the annual demand is
$800,000, the ordering cost is $32, and the cost of carrying inventory is 20%. Calculate
the following:
a. The EOQ in dollars.
b. Number of orders per year.
c. Cost of ordering, cost of carrying inventory, and total cost.
d. Compare your answers to those in problem 10.3.
Answer.
a. $16,000
b. Number of orders per year = 50
c. Annual cost of ordering = $1600
Annual cost of carrying = $1600
Annual total cost = $3200
d. Results are the same.
298
Chapter 10
10.5 An SKU has an annual demand of 10,000 units, each costing $10, ordering costs are $200
per order, and the cost of carrying inventory is 20%. Calculate the EOQ in units and
then convert to dollars.
10.6 A company is presently ordering on the basis of an EOQ. The demand is 10,000 units a
year, unit cost is $10, ordering cost is $30, and the cost of carrying inventory is 20%. The
supplier offers a discount of 3% on orders of 1000 units or more. What will be the saving
(loss) of accepting the discount?
Answer.
Savings = $2825.45
10.7 Refer to problem 10.3. The supplier offers a 3% discount on orders of 5000 units.
Calculate the purchase cost, the cost of ordering, the cost of carrying, and the total cost
if orders of 5000 are placed. Compare the results and calculate the savings if the discount
is taken.
10.8 Calculate the new lot size for the following if K = 5
Item
Annual Demand
1
2500
2
900
3
121
Answer.
Item 1
250
Item 2
150
Item 3
55
AD
New Lot Size
AD
10.9 Calculate K for the following data:
Item
Annual Demand
Orders per Year
11
$14,400
5
2
4900
5
3
1600
5
Totals
Answer.
K = 15.33
10.10 A company manufactures three sizes of lightning rods. Ordering costs and carrying costs
are not known, but it is known that they are the same for each size. Each size is produced
299
Order Quantities
six times per year. If the demand for each size is as follows, calculate order quantities to
minimize inventories and maintain the same total number of runs. Calculate the old and
new average inventories. Is there any change in the number of orders per year?
Item
Annual
Usage
Present
Orders
per Year
1
$22,500
6
2
$5625
6
3
$1600
6
Present
Lot Size
AD
New Lot Size
= K AD
New Orders
per Year
N = AD/Q
Totals
Average Inventory
Average inventory with present lot sizes = $2477.08
Answer.
Average inventory with new lot sizes = $1950.69
10.11 A company manufactures five sizes of screwdrivers. Ordering costs and carrying costs are
not known, but it is known that they are the same for each size. At present, each size is produced four times per year. If the demand for each size is as follows, calculate order quantities to minimize inventories and maintain the same total number of runs. Calculate the old
and new average inventories. Is there any change in the number of orders per year?
Item
Annual
Usage
Present
Orders
per Year
1
$10,000
4
2
$6400
4
3
$3600
4
4
$1600
4
5
$400
4
Totals
Average Inventory
Present
Lot Size
AD
New Lot Size
= K AD
New Orders
per Year
N = AD/Q
300
Chapter 10
10.12 The EOQ for an item is 1150 units, and the annual usage is 15,600 units. What is the
period-order quantity?
Answer.
4 weeks
10.13 Given the following net requirements, calculate the planned order receipts based on the
period-order quantity. The EOQ is 300 units, and the annual demand is 4200 units.
Week
Net Requirements
1
2
3
4
5
6
7
8
100
75
90
90
85
70
80
40
630
Planned Order Receipts
Answer.
POQ is 4 weeks
Planned order period 1 = 355 units
Planned order period 5 = 275 units
10.14 Given the following MRP record and an EOQ of 200 units, calculate the planned order
receipts using the economic-order quantity. Next, calculate the period-order quantities
and the planned order receipts. In both cases, calculate the ending inventory and the
total inventory carried over the 10 weeks.
Week
1
2
3
4
5
6
7
8
9
10
Net
Requirements
75
100
60
0
100
80
70
60
0
60
Total
Planned Order
Receipt
Ending
Inventory
Answer.
EOQ total ending inventory = 1150 units
POQ total ending inventory = 560 units
10.15 An item has a weekly demand of 120 units throughout the year. The item has a unit
value of $24 and the company uses 16% of the item value for the annual inventory cost.
When ordered, the setup cost to produce an order is $600, and the production process
is able to produce 300 per week and deliver them weekly as produced. What is the
economic-order quantity?
Order Quantities
301
CARL’S COMPUTERS
There was no question about Carl’s genius. Seven years ago he decided to enter the
competitive nightmare that the personal computer business had become. Although
on the surface that appeared to be a rather nongenius-like move, the genius came in
the unique designs and features that he developed for his computer. He also figured
a way to promise delivery in only two days for the local and regional market. Other
computer makers also had rapid production and delivery, but they were national
competitors, and the delivery time from distant locations generally made Carl able to
outcompete them on delivery.
Carl soon had a loyal following, especially among the many small businesses in
the area. Not only could Carl deliver quickly, but he also had very rapid service to
deal with any technical problems. That service feature became critical for the local
businesses whose very livelihood depended on the computers, and soon that rapid
service capability became more important than the initial product delivery. Since
most of these businesses were fairly small, they could not afford to have their own inhouse computer experts, so they depended heavily on Carl.
The Current Situation
All was not totally rosy at Carl’s Computers, however. Recently they had hired Rosa
Chang for the newly developed position of Inventory Manager for Aftermarket
Service. In the first week Rosa got a good idea of the challenges facing her after she
interviewed several of the people at Carl’s.
RANDY SMITH, CUSTOMER SERVICE MANAGER: “I’m not sure what you need to do, but whatever it is needs to be done fast! At this point our main competitive edge other than product delivery is service response, and I’m always hearing that we can’t get a unit in the
field serviced because some critical part is missing. Both the customers and the field service people are complaining about it. They make a service call, find out they need a certain part, but in many cases we’re out of the part. The customers tend to be fairly loyal,
but their patience is wearing thin—our policy is to provide at least a 98% customer service level, and we’re not even close. That’s not the only problem, though. Since our service is declining, the customers are looking more closely at our prices. I’d like to cut
them a break, but our financial people tell us our margins are already too thin, and get
this—one major reason is that our inventory and associated inventory costs are too high!
It looks to me as if we have a very large amount of the wrong stuff here. I don’t know that
for sure, but I sure hope you can find a solution, and fast!”
ELLEN BEDROSIAN, CHIEF ENGINEER: “Boy, am I glad you’re here! The inventory problems are
killing us in engineering. Carl’s has always been known for unique designs, and we’ve been
trying hard to keep ahead of the competitive curve on that issue. The problem is that most
of the time when we push hard to get a new design out, the inventory and financial people
tell us we have to wait. It seems like they always have too much of the old design inventory
around, and the financial “hit” to make it immediately obsolete would be too severe. We’re
told that as soon as we announce a new design many of our customers would want it, so
that tends to make most existing old design material—even for service—obsolete. We try
302
Chapter 10
to tell the service inventory people when we have a new design coming so they can use up
the old material, but somehow it never seems to work out.”
JIM HUGHES, PURCHASING MANAGER: “Well, Rosa, I wish you luck—you’ll need it. I’m getting pressure from so many directions, sometimes I don’t know how to respond. First,
the financial people are always telling me to cut or control costs. The engineers then are
always coming out with new designs, most of which represent purchased parts. A lot of
our time is spent working with suppliers on the new designs, while trying to get them to
have very rapid delivery with low prices. Although most can live with that, where we
really jerk them around is with the changes in orders. One minute our field service people tell us they’ve run out of something and they need delivery immediately. In many
cases they don’t even have an order for that part on the books. The next thing you know
they want us to cancel an order for something that only a day before they said was critical. Our buyers and suppliers are good, but they’re not miracle workers and they can’t do
everything at once. Some of our suppliers are even threatening to refuse our business if
we don’t get our act together. We’ve tried to offer solutions for the field service people,
but nothing seems to work. Maybe they just don’t care.”
MARY SHOULTON, CHIEF FINANCIAL OFFICER: “If you can help us with this inventory problem, you’ll be well worth your salary, and then some! Here we are being competitively
crunched for price, delivery, and efficient service, and our service inventory costs seem
to have gone completely out of control. The total inventory has climbed more than 200%
in the last two years while our service revenues have only grown 15%. On top of that, we
have had an increase in obsolete material write-off of 80% in that same two-year period.
In addition, significant inventory-related costs have come from expediting. Premium
freight shipments, such as flying in parts, caused by critical part shortages cost us over
$67,000 last year alone. Do you realize that represents almost 20% of our gross profit
margin from the service business? With our interest rates, warehousing, and obsolete
inventory costs, we recognize a 23% inventory holding cost. Given our huge inventory
level, that takes another big bite our of profits. All this suggests to me we need to get
control of the situation or we may find ourselves out of business!”
FRANKLIN KNOWLES, FIELD SERVICE SUPERVISOR: “Until they hired you, the other production
supervisor and I had been in charge of inventory. I hate to discourage you, but it looks like
an impossible job. The purchasing people bought a bunch of standard-size bins, and they
told us that as soon as we had a week’s average part usage for each part to order more—
specifically, “enough to fill up the bin.” Since most of their lead times were a week or less,
it sure made sense. All the records were kept on computer, therefore the computer could
be programmed to tell us when we had only the week’s supply. It made great sense to me,
but something kept going wrong. First, field service technicians seemed to frequently grab
parts without filling out a transaction. That made our records go to pot. As a matter of
fact, we had a complete physical inventory a couple of months ago, and it showed our
records to be less than 30% accurate! I suspect our records are almost that bad again, and
we don’t have another physical inventory scheduled for another nine months.
“Second, with our records so bad the field service technicians can never tell if we really
have the parts or not. Several of them have started to take large quantities of critical parts
and are keeping their own inventory. When it comes time to replace their own “private
stock,” they take a bunch more. That has made the demand on the central inventory
appear very erratic. One day we have plenty, and the next day we’re out! You can imagine
how happy purchasing is when the first time they see a purchase order it is requesting an
immediate urgent shipment. We’ve made a policy that the technicians are only supposed
Order Quantities
303
to have a few specifically authorized parts with them, but I’m sure many of the technicians
are violating that policy big time.”
QUENTIN BATES, FIELD SERVICE TECHNICIAN: “Something is drastically wrong with our inventory, and it’s driving me and the other techs crazy. We’re not supposed to keep much
inventory with us, only a few commonly used parts. If we have a field problem requiring
a part, we’re supposed to be getting it from the central inventory. Problem is, much of
the time it’s not there. We have to take time to pressure purchasing for it, and then have
to try to calm our customers while we wait for delivery. In the meantime, the customers’
systems are often unusable, and they’re losing business. It doesn’t take too long before
they’re really mad at us. I guess the people at purchasing don’t care, since we have to
take all the heat. Lately I’ve been taking and keeping a bunch of parts I’m not really supposed to have in my inventory, and I know the other field technicians do also. That’s
saved us a few times, but the situation seems to be getting worse.”
Now that Rosa had some real information as to the nature of the problems, she
needed to start developing solutions—and it appeared that it was important to come
up with good solutions fast! The first thing she tried to do was take a couple of part
numbers at random and see if she could improve on the ordering approach.
The first number she selected was the A233 circuit board. The average weekly
usage was 32. The lead time was given as one week. The board cost $18, and the cost
to place an order was given as $16. The quantity ordered to fill the bin was usually 64.
The second number was the P656 power supply. It cost $35, but since the supplier
only required a fax to order the cost was only $2 per order. Even with the fax the
delivery lead time was two weeks. The average weekly demand for the power supply
was 120. The company typically ordered 350 units at a time. Recently the supplier for
the circuit board hinted that it might be able to give Carl’s a price break of $2 per
board if Carl’s would order 200 or more at a time.
Case Analysis
1. Using the data on the two part numbers given, provide a comprehensive evaluation of
the ordering policies. Compare the present annual average cost with the cost of using a
system such as EOQ, and discuss any other order policies as appropriate.
2. Should Carl’s pursue the price break? Why or why not?
3. What do you think the sources of the other problems are? Be specific and analyze as
completely as possible.
4. Develop a comprehensive plan to help Rosa get the inventory back under control.
11
Independent Demand
Ordering Systems
INTRODUCTION
The concept of an economic-order quantity, covered in Chapter 10, addresses the
question of how much to order at one time. Another important question is when to
place a replacement order. If stock is not reordered soon enough, there will be a
stockout and a potential loss in customer service. However, stock ordered earlier
than needed will create extra inventory. The problem then is how to balance the costs
of carrying extra inventory against the costs of a stockout.
No matter what the items are, some rules for reordering are needed and can be
as simple as order when needed, order every month, or order when stock falls to a
predetermined level. We all use rules of some sort in our own lives, and they vary
depending on the significance of the item. A homemaker uses some intuitive rules to
make up the weekly shopping list. Order enough meat for a week, order salt when the
box is empty, order vanilla extract if it will be needed over the next week, and so on.
In industry there are many inventories that involve a large investment and have
high stockout costs. Controlling these inventories requires effective reorder systems.
Three basic systems are used to determine when to order:
• Order point system.
• Periodic review system.
• Material requirements planning.
304
Independent Demand Ordering Systems
305
The first two are for independent demand items; the last is for dependent
demand items.
ORDER POINT SYSTEM
When the quantity of an item on hand in inventory falls to a predetermined level,
called an order point, an order is placed. The quantity ordered is usually precalculated and based on economic-order-quantity concepts.
Using this system, an order must be placed when there is enough stock on
hand to satisfy demand from the time the order is placed until the new stock arrives
(called the lead time). Suppose that for a particular item the average demand is 100
units a week and the lead time is four weeks. If an order is placed when there are
400 units on hand, on the average there will be enough stock on hand to last until
the new stock arrives. However, demand during any one lead-time period probably
varies from the average—sometimes more and sometimes less than the 400.
Statistically, half the time the demand is greater than average, and there is a stockout; half the time the demand is less than average, and there is extra stock. If it is
necessary to provide some protection against a stockout, safety stock can be added.
The item is ordered when the quantity on hand falls to a level equal to the demand
during the lead time plus the safety stock:
OP = DDLT + SS
Where
OP = order point
DDLT = demand during the lead time
SS = stock
It is important to note that it is the demand during the lead time that is important. The
only time a stockout is possible is during the lead time. If demand during the lead time is
greater than expected, there will be a stockout unless sufficient safety stock is carried.
EXAMPLE PROBLEM
Demand is 200 units a week, the lead time is 3 weeks, and safety stock is 300 units.
Calculate the order point.
Answer
OP = DDLT + SS
= 200 * 3 + 300
= 900 units
Chapter 11
Figure 11.1 Quantity
on hand versus time:
independent demand
item.
UNITS IN STOCK
306
Q = Order
Quantity
Order Point
Safety Stock
Lead Time
Figure 11.1 shows the relationship between safety stock, lead time, order quantity, and order point. With the order point system:
• Order quantities are usually fixed.
• The order point is determined by the average demand during the lead time. If
the average demand or the lead time changes and there is no corresponding
change in the order point, effectively there has been a change in safety stock.
• The intervals between replenishment are not constant but vary depending on
the actual demand during the reorder cycle.
• The average inventory for a period is equal to the opening inventory plus the
ending inventory, divided by 2.
Period opening inventory = order quantity plus safety stock
Period ending inventory safety stock
order quantity + safety stock + safety stock
Average inventory
=
2
order quantity
=
+ safety stock
2
Q
=
+ SS
2
EXAMPLE PROBLEM
Order quantity is 1000 units and safety stock (SS) is 300 units. What is the average
inventory?
Answer
Q
+ SS
2
1000
=
+ 300
2
= 800 units
Average inventory =
Independent Demand Ordering Systems
307
Determining the order point depends on the demand during the lead time and
the safety stock required.
Methods of estimating the demand during the lead time were discussed in
Chapter 8. We now look at the factors to consider when determining safety stock.
DETERMINING SAFETY STOCK
Safety stock is intended to protect against uncertainty in supply and demand.
Uncertainty may occur in two ways: quantity uncertainty and timing uncertainty.
Quantity uncertainty occurs when the amount of supply or demand varies; for example, if the demand is greater or less than expected in a given period. Timing uncertainty occurs when the time of receipt of supply or demand differs from that
expected. A customer or a supplier may change a delivery date, for instance.
There are two ways to protect against uncertainty: carry extra stock, called
safety stock, or order early, called safety lead time. Safety stock is a calculated extra
amount of stock carried and is generally used to protect against quantity uncertainty.
Safety lead time is used to protect against timing uncertainty by planning order
releases and order receipts earlier than required. Safety stock and safety lead time
both result in extra inventory, but the methods of calculation are different.
Safety stock is the most common way of buffering against uncertainty and is the
method described in this text. The safety stock required depends on the following:
•
•
•
•
Variability of demand during the lead time.
Frequency of reorder.
Service level desired.
Length of the lead time. The longer the lead time, the more safety stock has to
be carried to provide a specified service level. This is one reason it is important
to reduce lead times as much as possible.
Variation in Demand During Lead Time
Chapter 8 discussed forecast error and said that actual demand varies from forecast
for two reasons: bias error in forecasting the average demand, and random variations
in demand about the average. It is the latter with which we are concerned in determining safety stock.
Suppose two items, A and B, have a 10-week sales history, as shown in
Figure 11.2. Average demand over the lead time of one week is 1000 per week for
both items. However, the weekly demand for A has a range from 700 to 1400 units a
week and that for B is from 200 to 1600 units per week. The demand for B is more
erratic than that for A. If the order point is 1200 units for both items, there will be
one stockout for A and four for B. If the same service level is to be provided (the
same chance of stockout for all items), some method of estimating the randomness of
item demand is needed.
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Chapter 11
Figure 11.2 Actual demand for
two items.
Week
1
2
3
4
5
6
7
8
9
10
Total
Average
Item A
Item B
1200
1000
800
900
1400
1100
1100
700
1000
800
400
600
1600
1300
200
1100
1500
800
1400
1100
10,000
1000
10,000
1000
Variation in Demand About the Average
Suppose over the past 100 weeks a history of weekly demand for a particular item
shows an average demand of 1000 units. As expected, most of the demands are
around 1000; a smaller number would be farther away from the average, and still
fewer would be farthest away. If the weekly demands are classified into groups or
ranges about the average, a picture of the distribution of demand about the average
appears. Suppose the demand is distributed as follows:
Weekly Demand
725–774
775–824
825–874
875–924
925–974
975–1024
1025–1074
1075–1124
1125–1174
1175–1224
1225–1274
Number of Weeks
2
3
7
12
17
20
17
12
7
3
2
These data are plotted to give the results shown in Figure 11.3. This is a
histogram.
Normal distribution. Everything in life varies—even identical twins in some
respects. The pattern of demand distribution about the average will differ for different products and markets. Some method is needed to describe the distribution—its
shape, center, and spread.
309
Independent Demand Ordering Systems
The shape of the histogram in Figure 11.3 indicates that although there is variation in the distribution, it follows a definite pattern, as shown by the smooth curve.
Such a natural pattern shows predictability. As long as the demand conditions remain
the same, we can expect the pattern to remain very much the same. If the demand is
erratic, so is the demand pattern, making it difficult to predict with any accuracy.
Fortunately, most demand patterns are stable and predictable.
The most common predictable pattern is similar to the one outlined by the histogram in Figure 11.3 and is called a normal curve, or bell curve, because its shape
resembles a bell. The shape of a perfectly normal distribution is shown in Figure 11.4.
Figure 11.3 Histogram of
actual demand.
25
FREQUENCY
20
15
10
5
0
725 775 825 875 925 975 1025 1075 1125 1175 1225
WEEKLY DEMAND
Figure 11.4 Normal
distribution.
2.1%
.2%
13.6%
−3
2.1%
34.1% 34.1%
−2
−1
.2%
13.6%
0
+1
Standard Deviation
+2
+3
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Chapter 11
The normal distribution has most of the values clustered near a central point
with progressively fewer results occurring away from the center. It is symmetrical
about this central point in that it spreads out evenly on both sides.
The normal curve is described by two characteristics. One relates to its central
tendency, or average, and the other to the variation, or dispersion, of the actual values about the average.
Average or mean. The average or mean value is at the high point of the curve. It
is the central tendency of the distribution. The symbol for the mean is x (pronounced
“x bar”). It is calculated by adding the data and dividing by the total number of data.
In mathematical terms, it can be written as:
x =
gx
n
Where x stands for the individual data (in this case, the individual demands (capital Greek letter sigma) is the summation sign, and n is the number of data (demands).
EXAMPLE PROBLEM
Given the following actual demands for a 10-week period, calculate the average x of
the distribution.
Period
Actual Demand
1
1200
2
1000
3
800
4
900
5
1400
6
1100
7
1100
8
700
9
1000
10
800
Total
10,000
Independent Demand Ordering Systems
311
Answer
x =
10,000
gx
=
= 1000 units
n
10
Dispersion. The variation, or dispersion, of actual demands about the average
refers to how closely the individual values cluster around the mean or average. It can
be measured in several ways:
• As a range of the maximum minus the minimum value.
• As the mean absolute deviation (MAD), which is a measure of the average forecast error. (Calculation of MAD was discussed in Chapter 8.)
• As a standard deviation.
Standard Deviation (Sigma)
The standard deviation is a statistical value that measures how closely the individual
values cluster about the average. It is represented by the Greek letter sigma (). The
standard deviation is calculated as follows:
1. Calculate the deviation for each period by subtracting the actual demand from
the forecast demand.
2. Square each deviation.
3. Add the squares of the deviations.
4. Divide the value in step 3 by the number of periods to determine the average of
the squared deviations.
5. Calculate the square root of the value calculated in step 4. This is the standard
deviation.
It is important to note that the deviations in demand are for the same time
intervals as the lead time. If the lead time is one week, then the variation in demand
over a one-week period is needed to determine the safety stock.
EXAMPLE PROBLEM
Given the data from the previous example problem, calculate the standard deviation
(sigma).
312
Chapter 11
Answer
Period
Forecast demand
Actual demand
Deviation
Deviation squared
1
1000
1200
200
40000
2
1000
1000
0
0
3
1000
800
200
40000
4
1000
900
100
10000
5
1000
1400
400
160000
6
1000
1100
100
10000
7
1000
1100
100
10000
8
1000
700
300
90000
9
1000
1000
0
0
10
1000
800
200
40000
Total
10000
10000
0
400000
Average of the squares of the deviation = 400,000 , 10 = 40,000
Sigma = 140,000 = 200 units
From statistics, we can determine that:
The actual demand will be within 1 sigma of the forecast average approximately 68% of the time.
The actual demand will be within 2 sigma of the forecast average approximately 98% of the time.
The actual demand will be within 3 sigma of the forecast average approximately 99.88% of the time.
Determining the Safety Stock and Order Point
Now that we have calculated the standard deviation, we must decide how much safety
stock is needed.
One property of the normal curve is that it is symmetrical about the average. This
means that half the time the actual demand is less than the average and half the time it
is greater. Safety stocks are needed to cover only those periods in which the demand
Independent Demand Ordering Systems
313
during the lead time is greater than the average. Thus, a service level of 50% can be
attained with no safety stock. If a higher service level is needed, safety stock must be provided to protect against those times when the actual demand is greater than the average.
As stated, we know from statistics that the error is within ± 1 sigma of the forecast about 68% of the time (34% of the time less and 34% of the time greater than
the forecast).
Suppose the standard deviation of demand during the lead time is 100 units and
this amount is carried as safety stock. This much safety stock provides protection
against stockout for the 34% of the time that actual demand is greater than expected.
In total, there is enough safety stock to provide protection for the 84% of the time
(50% + 34% = 84%) that a stockout is possible.
The service level is a statement of the percentage of time there is no stockout.
But what exactly is meant by supplying the customer 84% of the time? It means being
able to supply when a stockout is possible, and a stockout is possible only at the time
an order is to be placed. If we order 100 times a year, there are 100 chances of a stockout. With safety stock equivalent to one mean absolute deviation, on the average we
would expect no stockouts about 84 of the 100 times.
EXAMPLE PROBLEM
Using the figures in the last example problem in which the sigma was calculated as
200 units,
a. Calculate the safety stock and the order point for an 84% service level.
b. If a safety stock equal to two standard deviations is carried, calculate the safety
stock and the order point.
Answer
a. Safety stock =
=
=
Order point =
=
1 sigma
1 * 200
200 units
DDLT + SS
1000 + 200 = 1200 units
where DDLT and SS are as defined previously. With this order point and level of
safety stock, on the average there are no stockouts 84% of the time when a stockout
is possible.
b. SS = 2 * 200
= 400 units
OP = DDLT + SS
= 1000 + 400
= 1400 units
314
Chapter 11
Figure 11.5 Table of safety
factors.
Service Level (%)
Safety Factor
50
75
80
85
90
94
95
96
97
98
99
99.86
99.99
0.00
0.67
0.84
1.04
1.28
1.56
1.65
1.75
1.88
2.05
2.33
3.00
4.00
Safety factor. The service level is directly related to the number of standard deviations provided as safety stock and is usually called the safety factor.
Figure 11.5 shows safety factors for various service levels. Note that the service level is the percentage of order cycles without a stockout. For values not
shown on the table, you can make a close approximation of the safety factor by
interpolating the factors given. For example, to find the safety factor for a desired
service level of 77%, calculate the average safety factor for a 75% service level
(.67) and an 80% service level (.84). The safety factor for a 77% service level
would be approximately:
1.67 + .842>2 = 76
EXAMPLE PROBLEM
If the standard deviation is 200 units, what safety stock should be carried to provide a
service level of 90%? If the expected demand during the lead time is 1500 units, what
is the order point?
Answer
From Figure 11.5, the safety factor for a service level of 90% is 1.28. Therefore,
Safety stock = sigma * safety factor
200 1.28
256 units
Order point DDLT SS
315
Independent Demand Ordering Systems
1500 256
1756 units
DETERMINING SERVICE LEVELS
Theoretically, we want to carry enough safety stock on hand so the cost of carrying
the extra inventory plus the cost of stockouts is a minimum. Stockouts cost money for
the following reasons:
• Back-order costs.
• Lost sales.
• Lost customers.
Figure 11.6 Exposures to
stockout.
STOCK ON HAND
The cost of a stockout varies depending on the item, the market served, the customer, and competition. In some markets, customer service is a major competitive tool,
and a stockout can be very expensive. In others, it may not be a major consideration.
Stockout costs are difficult to establish. Usually the decision about what the service
level should be is a senior management decision and is part of the company’s corporate
and marketing strategy. As such, it is beyond the scope of this text.
The only time it is possible for a stockout to occur is when stock is running low,
and this happens every time an order is to be placed. Therefore, the chances of a
stockout are directly proportional to the frequency of reorder. The more often stock
is reordered, the more often there is a chance of a stockout. Figure 11.6 shows the
effect of the order quantity on the number of exposures per year. Note also that when
the order quantity is increased, exposure to stockout decreases. The safety stock
needed decreases, but because of the larger order quantity, the average inventory
increases.
It is the responsibility of management to determine the number of stockouts
per year that are tolerable. Then the service level, safety stock, and order point can be
calculated.
Two Exposures
One Exposure
316
Chapter 11
EXAMPLE PROBLEM
Suppose management stated that it could tolerate only one stockout per year for a
specific item.
For this particular item, the annual demand is 52,000 units, it is ordered
in quantities of 2600, and the standard deviation of demand during the lead time is
100 units. The lead time is one week. Calculate:
a.
b.
c.
d.
Number of orders per year.
Service level.
Safety stock.
Order point.
Answer
a. Number of orders per year =
=
annual demand
order quantity
52,000
= 20 times per year
2600
b. Since one stockout per year is tolerable, there must be no stockouts
19 (20 1) times per year.
Service level =
20 - 1
= 95%
20
c. From Figure 11.5
Safety factor = 1.65
Safety stock = safety factor * sigma
= 1.65 * 100 = 165 units
d. Demand during lead time = 11 week2
(52,000)
52
= 1000 units
Order point = demand during lead time + SS
= 1000 + 165 = 1165 units
DIFFERENT FORECAST AND LEAD-TIME INTERVALS
Usually, there are many items in an inventory, each with different lead times. Records
of actual demand and forecasts are normally made on a weekly or monthly basis for
all items regardless of what the individual lead times are. It is almost impossible to
317
Independent Demand Ordering Systems
measure the variation in demand about the average for each of the lead times. Some
method of adjusting standard deviation for the different time intervals is needed.
If the lead time is zero, the standard deviation of demand is zero. As the lead
time increases, the standard deviation increases. However, it will not increase in
direct proportion to the increase in time. For example, if the standard deviation is 100
for a lead time of one week, then for a lead time of four weeks it will not be 400, since
it is very unlikely that the deviation would be high for four weeks in a row. As the time
interval increases, there is a smoothing effect, and the longer the time interval, the
more smoothing takes place.
The following adjustment can be made to the standard deviation or the safety
stock to compensate for differences between lead-time interval (LTI) and forecast
interval (FI). Although not exact, the formula gives a good approximation:
LTI
sigma for LTI = 1sigma for FI2
A FI
EXAMPLE PROBLEM
The forecast interval is 4 weeks, the lead time interval is 2 weeks, and sigma for the
forecast interval is 150 units. Calculate the standard deviation for the lead-time
interval.
Answer
sigma for LTI = 150 224 = 150 * 0.707 = 106 units
The preceding relationship is also useful where there is a change in the LTI.
Now it is probably more convenient to work directly with the safety stock rather than
the mean absolute deviation. The relationship is as follows:
New safety stock = old safety stock
new interval
A old interval
EXAMPLE PROBLEM
The safety stock for an item is 150 units, and the lead time is 2 weeks. If the lead time
changes to 3 weeks, calculate the new safety stock.
Answer
SS 1new2 = 150 232
= 150 * 1.22 = 183 units
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Chapter 11
DETERMINING WHEN THE ORDER POINT IS REACHED
There must be some method to show when the quantity of an item on hand has
reached the order point. In practice, there are many systems, but they all are inclined
to be variations or extensions of three basic systems: the two-bin system, the Kanban
system, and the perpetual inventory record system.
Two-Bin System
A quantity of an item equal to the order point quantity is set aside (frequently in a
separate or second bin) and not touched until all the main stock is used up. When this
stock needs to be used, the production control or purchasing department is notified
and a replenishment order is placed.
There are variations on this system, such as the red-tag system, where a tag is
placed in the stock at a point equal to the order point. Bookstores frequently use this
system. A tag or card is placed in a book that is in a stack in a position equivalent to
the order point. When a customer takes that book to the checkout, the store is effectively notified that it is time to reorder that title.
The two-bin system is a simple way of keeping control of C items. Because they
are of low value, it is best to spend the minimum amount of time and money controlling them. However, they do need to be managed, and someone should be assigned to
ensure that when the reserve stock is reached an order must be placed. When it is out
of stock, a C item becomes an A item.
Kanbans
The Kanban system is a simple system that signals the need for more product. It normally consists of a card or ticket that has information on the item and the quantity to
be produced. It avoids the need for formal record keeping and, like the two-bin system, makes a visual signal of the need for more product when the inventory falls
below a preset level. It is used to replenish all items and not just low-value C items.
Kanbans are discussed in detail in Chapter 15.
Perpetual Inventory Record System
A perpetual inventory record is a continual account of inventory transactions as they
occur. At any instant, it holds an up-to-date record of transactions. At a minimum, it
contains the balance on hand, but it may also contain the quantity on order but not
received, the quantity allocated but not issued, and the available balance. The accuracy of the record depends upon the speed with which transactions are recorded and
the accuracy of the input. Because manual systems rely on the input of humans, they
are more likely to have slow response and inaccuracies. Computer-based systems
have a higher transaction speed and reduce the possibility of human error.
An inventory record contains variable and permanent information. Figure 11.7
shows an example of a perpetual inventory record.
319
Independent Demand Ordering Systems
426254 SCREW
DATE
01
02
03
04
05
ORDERED
ORDER
QUANTITY
500
RECEIVED
ISSUED
500
400
500
ON HAND
500
500
500
100
600
ORDER
POINT
100
ALLOCATED
AVAILABLE
400
500
100
0
0
100
600
Figure 11.7 Perpetual inventory record.
Permanent or static information is shown at the top of Figure 11.7. Although
not absolutely permanent, this information does not change frequently. Any alteration is usually the result of an engineering change, manufacturing process change, or
inventory management change. It includes data such as the following:
•
•
•
•
•
•
•
Part number, name, and description.
Storage location.
Order point.
Order quantity.
Lead time.
Safety stock.
Suppliers.
Variable or dynamic information changes with each transaction and includes
the following:
•
•
•
•
•
•
Quantities ordered: dates, order numbers, and quantities.
Quantities received: dates, order numbers, and quantities.
Quantities issued: dates, order numbers, and quantities.
Balance on hand.
Allocated: dates, order numbers, and quantities.
Available balance.
The information depends on the needs of the company and the particular
circumstances.
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Chapter 11
PERIODIC REVIEW SYSTEM
In the order point system, an order is placed when the quantity on hand falls to a predetermined level called the order point. The quantity ordered is usually predetermined on some basis such as the economic-order quantity. The interval between
orders varies depending on the demand during any particular cycle.
Using the periodic review system, the quantity on hand of a particular item is
determined at specified, fixed-time intervals, and an order is placed. Figure 11.8 illustrates this system.
Figure 11.8 shows that the review intervals (t1, t2, and t3) are equal and that Q1,
Q2, and Q3 are not necessarily the same. Thus the review period is fixed, and the
order quantity is allowed to vary. The quantity on hand plus the quantity ordered
must be sufficient to last until the next shipment is received. That is, the quantity on
hand plus the quantity ordered must equal the sum of the demand during the lead
time plus the demand during the review period plus the safety stock.
Target-Level or Maximum-Level Inventory
The quantity equal to the demand during the lead time plus the demand during the
review period plus safety stock is called the target-level or maximum-level inventory:
T = D 1R + L2 + SS
where
T = target (maximum) inventory level
D = demand per unit of time
L = lead-time duration
R = review-period duration
SS = safety stock
TARGET
LEVEL
UNITS IN STOCK
Figure 11.8 Periodic review
system: units in stock versus
time.
Q2
Q1
L
R1
Q3
L
t1
R2
L
t2
R3
L
t3
R4
321
Independent Demand Ordering Systems
The order quantity is equal to the maximum-inventory level minus the quantity
on hand at the review period:
Q = T - I
where
Q = order quantity
I = inventory on hand
The periodic review system is useful for the following:
• Where there are many small issues from inventory, and posting transactions
to inventory records are very expensive. Supermarkets and retailers are in this
category.
• Where ordering costs are small. This occurs when many different items are
ordered from one source. A regional distribution center may order most or all
of its stock from a central warehouse.
• Where many items are ordered together to make up a production run or fill a
truckload. A good example of this is a regional distribution center that orders a
truckload once a week from a central warehouse.
EXAMPLE PROBLEM
A hardware company stocks nuts and bolts and orders them from a local supplier
once every 2 weeks (10 working days). Lead time is 2 days. The company has determined that the average demand for 1⁄2 -inch bolts is 150 per week (5 working days), and
it wants to keep a safety stock of 3 days’ supply on hand. An order is to be placed this
week, and stock on hand is 130 bolts.
a. What is the target level?
b. How many 1⁄2 -inch bolts should be ordered this time?
Answer
Let
D = demand per unit of time = 150 , 5 = 30 per working day
L = lead-time duration = 2 days
R = review period duration = 10 days
SS = safety stock = 3 days’ supply = 90 units
I inventory on hand = 130 units
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Chapter 11
Then
a.
b.
Target level T = D1R + L2 + SS
= 30110 + 22 + 90
= 450 units
Order quantity Q = T - I
= 450 - 130 = 320 units
DISTRIBUTION INVENTORY
Distribution inventory includes all the finished goods held anywhere in the distribution system. The purpose of holding inventory in distribution centers is to improve
customer service by locating stock near the customer and to reduce transportation
costs by allowing the manufacturer to ship full loads rather than partial loads over
long distances. This will be studied in Chapter 13.
The objectives of distribution inventory management are to provide the
required level of customer service, to minimize the costs of transportation and handling, and to be able to interact with the factory to minimize scheduling problems.
Distribution systems vary considerably, but in general they have a central supply
facility that is supported by a factory, a number of distribution centers, and, finally,
customers. Figure 11.9 is a schematic of such a system. The customers may be the
final consumer or some intermediary in the distribution chain.
Unless a firm delivers directly from factory to customer, demand on the factory is
created by central supply. In turn, demand on central supply is created by the distribution centers. This can have severe repercussions on the pattern of demand on central
supply and the factory. Although the demand from customers may be relatively uniform,
FACTORY
CENTRAL
SUPPLY
DISTRIBUTION
CENTER A
DISTRIBUTION
CENTER B
CUSTOMERS
Figure 11.9 Schematic of a distribution system.
DISTRIBUTION
CENTER C
323
Independent Demand Ordering Systems
DEMAND
Demand at distribution
center is uniform.
0
TIME
Order
Point
DISTRIBUTION
INVENTORY
LEVELS
0
Distribution centers
order when their order
point is reached.
TIME
ORDER
ORDER
REORDER
QUANTITY
CENTRAL
SUPPLY
DEMAND
Demand at central
supply is lumpy.
0
TIME
Figure 11.10 Distribution inventory.
the demand on central supply is not, because it is dependent on when the distribution
centers place replenishment orders. In turn, the demand on the factory depends on
when central supply places orders. Figure 11.10 shows the process schematically.
The distribution system is the factory’s customer, and the way the distribution
system interfaces with the factory has a significant effect on the efficiency of factory
operations.
Distribution inventory management systems can be classified into decentralized, centralized, and distribution requirements planning.
Decentralized System
In a decentralized system, each distribution center first determines what it needs and
when, and then places orders in central supply. Each center orders on its own without
regard for the needs of other centers, available inventory at central supply, or the production schedule of the factory.
The advantage of the decentralized system is that each center can operate on its
own and thus reduce communication and coordination expense. The disadvantage is
the lack of coordination and the effect this may have on inventories, customer service, and factory schedules. Because of these deficiencies, many distribution systems
have moved toward more central control.
A number of ordering systems can be used, including the order point and
periodic review systems. The decentralized system is sometimes called the pull
system because orders are placed on central supply and “pulled” through the system.
324
Chapter 11
Centralized System
In a centralized system, all forecasting and order decisions are made centrally. Stock
is “pushed” out into the system from central supply. Distribution centers have no say
about what they receive.
Different ordering systems can be used, but generally an attempt is made to
replace the stock that has been sold and to provide for special situations such as seasonality or sales promotions. These systems attempt to balance the available inventory with the needs of each distribution center.
The advantage of these systems is the coordination between factory, central
supply, and distribution center needs. The disadvantage is the inability to react to
local demand, thus lowering the level of service.
Distribution Requirements Planning
Distribution requirements planning is a system that forecasts when the various
demands will be made by the system on central supply. This gives central supply and the
factory the opportunity to plan for the goods that will actually be needed and when. It is
able both to respond to customer demand and coordinate planning and control.
The system translates the logic of material requirements planning to the distribution system. Planned order releases from the various distribution centers become
the input to the material plan of central supply. The planned order releases from central supply become the forecast of demand for the factory master production schedule. Figure 11.11 shows the system schematically. The records shown are all for the
same part number.
Distribution Center A
Part 5678
Week
Planned Order Release
Distribution Center B
Part 5678
1
2
200
3
Week
200
1
Planned Order Release
Central Supply
Part 5678
Lead Time: 2 weeks
Order Quantity: 500
Week
1
Gross Requirements
2
3
200 100 200
Scheduled Receipts
Projected Available
400 200 100 400
Planned Order Release
Figure 11.11 Distribution requirements planning.
500
2
100
3
325
Independent Demand Ordering Systems
EXAMPLE PROBLEM
A company making lawnmowers has a central supply attached to its factory and two
distribution centers. Distribution center A forecasts demand at 25, 30, 55, 50, and 30
units over the next 5 weeks and has 100 lawnmowers in transit that are due in week 2.
The transit time is 2 weeks, the order quantity is 100 units, and there are 50 units on
hand. Distribution center B forecasts demand at 95, 85, 100, 70, and 50 over the next 5
weeks. Transit time is 1 week, the order quantity is 200 units, and there are 100 units
on hand. The central warehouse has a lead time of 1 week, the order quantity is
500 units and there are 400 on hand. Calculate the gross requirements, projected available, and planned order releases for the two distribution centers, and the gross requirements, projected available, and planned order releases for the central warehouse.
Answer
Distribution Center A
Transit Time:
2 weeks
Order Quantity: 100 units
Week
1
2
3
4
5
Gross Requirements
25
30
55
50
30
40
90
60
In Transit
100
Projected Available
50
25
Planned Order Release
95
100
Distribution Center B
Transit Time:
1 week
Order Quantity: 200 units
Week
Gross Requirements
1
2
3
4
5
95
85
100
70
50
5
120
20
150
100
In Transit
Projected Available
100
Planned Order Release
200
200
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Chapter 11
Central Supply
Lead Time:
Order Quantity:
2 weeks
500 units
Week
Gross Requirements
1
2
3
200
100
200
200
100
400
4
5
Scheduled Receipts
Projected Available
400
Planned Order Release
500
KEY TERMS
Order point 305
Lead time 305
Safety stock 307
Safety lead time 307
Normal curve or bell
curve 309
Normal distribution 310
Average or mean 310
Dispersion 311
Standard deviation
(sigma) 311
Safety factor 314
Two-bin system 318
Kanban system 318
Perpetual inventory
record 318
Permanent or static
information 319
Variable or dynamic
information 319
Target-level or maximumlevel inventory 320
Decentralized system 323
Centralized system 324
Distribution requirements
planning 324
QUESTIONS
1. What are independent demand items? What two basic ordering systems are used for
these items? What are dependent demand items? What system should be used to order
these items?
2. a. Using the order point system, when must an order be placed?
b. Why is safety stock carried?
c. What is the formula for the order point?
d. On what two things does the order point depend?
e. Why is the demand during the lead time important?
Independent Demand Ordering Systems
327
3. What are four characteristics of the order point system?
4. What are the five factors that can influence the amount of safety stock that should be
carried? How does the length of the lead time affect the safety stock carried?
5. What is a normal distribution? What two characteristics define it? Why is it important in
determining safety stock?
6. What is the standard deviation of demand during the lead time? If the standard deviation for the lead-time interval is 100 units, what percentage of the time would the actual
demand be equal to ; 100units? To ; 200 units? To ; 300 units?
7. What is service level?
8. What are the three categories of stockout costs? What do these costs depend upon in
any company?
9. Why does the service level depend upon the number of orders per year?
10. If the lead time increases from 1 week to 4 weeks, will the standard deviation of demand
during the lead time increase four times? If not, why not?
11. Describe the two-bin system.
12. What kinds of information are shown on a perpetual inventory record?
13. What are the differences between the order point system and the periodic review system
regarding when orders are placed and the quantity ordered at any one time?
14. Define the target level used in the periodic review system.
15. Describe how changes in demand will affect the order quantity when using the period
review system.
16. What are the objectives of distribution inventory management?
17. If a factory does not supply the customer directly, from where does demand on the factory come? Is it independent or dependent demand?
18. Describe and compare the pull and push systems of inventory management.
19. Describe distribution requirements planning.
20. Grocery stores are an example of well-controlled inventory and replenishment systems.
Describe in your own words examples of safety stock, the two-bin system, and the periodic review system, including target level, review period, replenishment period, and
order quantity.
PROBLEMS
11.1 For a particular SKU, the lead time is 4 weeks, the average demand is 125 units per
week, and safety stock is 100 units. What is the average inventory if 1600 units are
ordered at one time? What is the order point?
Answer.
Average inventory = 900 units
Order point = 600 units
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11.2 For a particular SKU, the lead time is 6 weeks, the average demand is 100 units a week,
and safety stock is 200 units. What is the average inventory if 10 weeks’ supply is ordered
at one time? What is the order point?
11.3 Given the following data, calculate the average x of the distribution and the standard
deviation (sigma).
Period
Actual
Demand
1
500
2
600
3
425
4
450
5
600
6
575
7
375
8
475
9
525
10
475
Deviation
Total
Answer.
Average demand x = 500 units
Sigma = 71.59 units
Deviation
Squared
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Independent Demand Ordering Systems
11.4 Given the following data, calculate the average demand and the standard deviation.
Period
Actual
Demand
1
1700
2
2100
3
1900
4
2200
5
2000
6
1800
7
2100
8
2300
9
2100
10
1800
Deviation
Deviation
Squared
Total
11.5 If sigma is 150 units, and the demand during the lead time is 200 units, calculate the
safety stock and order point for:
a. A 50% service level.
b. An 85% service level.
Use the table in Figure 11.5 to help you calculate your answer.
Answer.
a. Safety stock = zero
Order point = 200 units
b. Safety stock = 156 units
Order point = 356 units
11.6 The standard deviation of demand during the lead time is 100 units.
a. Calculate the safety stock required for the following service levels: 75%, 80%, 85%,
90%, 95%, 99.99%.
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b. Calculate the change in safety stock required to increase the service levels from 75%
to 80%, 80% to 85%, 85% to 90%, 90% to 95%, and 95% to 99.99%. What conclusion do you reach?
11.7 For an SKU, the standard deviation of demand during the lead time is 150 units, the
annual demand is 10,000 units, and the order quantity is 750 units. Management says it
will tolerate only one stockout per year. What safety stock should be carried? What is the
average inventory? If the lead time is 2 weeks, what is the order point?
Answer.
Safety stock = 213 units
Average inventory = 588
Order point = 598 units
11.8 A company stocks an SKU with a weekly demand of 250 units and a lead time of 3
weeks. Management will tolerate one stockout per year. If sigma for the lead time
is 175 and the order quantity is 800 units, what is the average inventory and the
order point?
11.9 A company stocks an SKU with a weekly demand of 500 units and a lead time of 4
weeks. Management will tolerate one stockout per year. If sigma for the lead time is
100 and the order quantity is 2500 units, what is the average inventory and the
order point?
11.10 If the standard deviation is calculated from weekly demand data at 100 units, what is the
equivalent sigma for a 3-week lead time?
Answer.
173 units
11.11 If the safety stock for an item is 200 units and the lead time is 3 weeks, what should the
safety stock become if the lead time is extended to 5 weeks?
Answer.
258 units
11.12 If the weekly standard deviation is 150 units, what is it if the lead time is 3 weeks?
11.13 The safety stock on an SKU is set at 200 units. The supplier says it can reduce the lead
time from 8 weeks to 6. What should be the new safety stock?
Answer.
173
11.14 The safety stock on an SKU is set at 200 units. The supplier says it has to increase the
lead time from 6 weeks to 8. What should be the new safety stock?
11.15 Management has stated that it will tolerate one stockout per year. The forecast of
annual demand for a particular SKU is 100,000 units, and it is ordered in quantities
of 10,000 units. The lead time is 2 weeks. Sales history for the past 10 weeks follows.
Calculate:
a. Sigma for the history time interval.
b. Sigma for the lead time interval.
c. The service level.
d. The safety stock required for this service level.
e. The order point.
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Independent Demand Ordering Systems
Week
Actual
Demand
1
2100
2
1700
3
2600
4
1400
5
1800
6
2300
7
2200
8
1600
9
2100
10
2200
Deviation
Deviation
Squared
Total
11.16 If in problem 11.15, management said that it is considering increasing the service level to
one stockout every 2 years, what would the new safety stock be? If the cost of carrying
inventory on this item is $10 per unit per year, what is the cost of increasing the inventory
from one stockout per year to one every 2 years?
11.17 The annual demand for an item is 10,000 units, the order quantity is 250, and the service
level is 90%. Calculate the probable number of stockouts per year.
Answer.
4 stockouts per year
11.18 A company that manufactures stoves has one plant and two distribution centers (DCs).
Given the following information for the two DCs, calculate the gross requirements, projected available, and planned order releases for the two DCs and the gross requirements,
projected available, and planned order releases for the central warehouse.
Distribution Center A
Transit Time:
2 weeks
Order Quantity: 100 units
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Week
Gross Requirements
1
2
3
4
5
50
50
35
50
110
3
4
5
115
80
70
4
5
In Transit
100
Projected Available
75
Planned Order Release
Distribution Center B
Transit Time:
1 week
Order Quantity: 200 units
Week
Gross Requirements
In Transit
1
2
95
100
200
Projected Available
50
Planned Order Release
Central Supply
Lead Time:
Order Quantity:
2 weeks
500 units
Week
1
2
3
Gross Requirements
Scheduled Receipts
Projected Available
400
Planned Order Release
Answer.
Planned order release from central supply: 500 in week 2.
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Independent Demand Ordering Systems
11.19 A company that manufactures snow shovels has one plant and two distribution centers
(DCs). Given the following information for the two DCs, calculate the gross requirements, projected available, and planned order releases for the two DCs and the gross
requirements, projected available, and planned order releases for the central warehouse.
Distribution Center A
Transit Time:
2 weeks
Order Quantity: 500 units
Week
1
2
Gross Requirements
300
200
In Transit
500
Projected Available
3
150
4
5
175
200
4
5
125
150
200
Planned Order Release
Distribution Center B
Transit Time:
2 weeks
Order Quantity: 200 units
Week
Gross Requirements
In Transit
Projected Available
150
Planned Order Release
1
2
3
50
75
100
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Central Supply
Lead Time:
Order Quantity:
1 week
600 units
Week
1
2
3
4
5
Gross Requirements
Scheduled Receipts
Projected Available
400
Planned Order Release
11.20 A firm orders a number of items from a regional warehouse every 2 weeks. Delivery
takes 1 week. Average demand is 200 units per week, and safety stock is held at 2 weeks’
supply.
a. Calculate the target level.
b. If 600 units are on hand, how many should be ordered?
Answer.
Target level = 1000 units
Order quantity = 400 units
11.21 A regional warehouse orders items once a week from a central warehouse. The truck
arrives 3 days after the order is placed. The warehouse operates 5 days a week. For a
particular brand and size of chicken soup, the demand is fairly steady at 20 cases per
day. Safety stock is set at 2 days’ supply.
a. What is the target level?
b. If the quantity on hand is 90 cases, how many should be ordered?
12
Physical Inventory and
Warehouse Management
INTRODUCTION
Because inventory is stored in warehouses, the physical management of inventory
and warehousing are intimately connected. In some cases, inventory may be stored
for an extended time. In other situations, inventory is turned over rapidly, and the
warehouse functions as a distribution center.
This chapter will deal with the physical management of inventory in a warehouse, including basic approaches to warehouse layout, the activities involved in handling goods, and the controls necessary to work efficiently while maintaining a
desired level of customer service. Inventory accuracy is the responsibility of warehousing, and methods of determining the accuracy of stocks will be covered, along
with a description of how to conduct an annual physical audit. The cycle counting
method of auditing inventory will show the advantages of timely correction of errors,
along with improved error prevention. Bar coding and radio frequency identification
(RFID) will be introduced as a means to improve the speed and accuracy of gathering information.
In a factory, “stores” perform the same functions as warehouses and contain
raw materials, work-in-process inventory, finished goods, supplies, and possibly
repair parts. Since they perform the same functions, stores and warehouses are
treated alike in this chapter.
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WAREHOUSING MANAGEMENT
As with other elements in a distribution system, the objective of a warehouse is to
minimize cost and maximize customer service. To do this, efficient warehouse operations perform the following:
• Provide timely customer service.
• Keep track of items so they can be found readily and correctly.
• Minimize the total physical effort and thus the cost of moving goods into and
out of storage.
• Provide communication links with customers.
The costs of operating a warehouse can be broken down into capital and operating costs. Capital costs are those of space and materials handling equipment. The
space needed depends on the peak quantities that must be stored, the methods of
storage, and the need for ancillary space for aisles, docks, offices, and so on.
The major operating cost is labor, and the measure of labor productivity is the
number of units (for example, pallets) that an operator can move in a day. This
depends on the type of material handling equipment used, the location and accessibility of stock, warehouse layout, stock location system, and the order-picking
system used.
Warehouse Activities
Operating a warehouse involves several processing activities, and the efficient operation of the warehouse depends upon how well these are performed. These activities
are as follows:
1. Receive goods. The warehouse accepts goods from outside transportation or an
attached factory and accepts responsibility for them. This means the warehouse
must:
a. Check the goods against an order and the bill of lading.
b. Check the quantities.
c. Check for damage and fill out damage reports if necessary.
d. Inspect goods if required.
2. Identify the goods. Items are identified with the appropriate stock-keeping unit
(SKU) number (part number) and the quantity received is recorded.
3. Dispatch goods to storage. Goods are sorted and put away.
4. Hold goods. Goods are kept in storage and under proper protection until
needed.
5. Pick goods. Items required from stock must be selected from storage and
brought to a marshalling area.
Physical Inventory and Warehouse Management
337
6. Marshal the shipment. Goods making up a single order are brought together and
checked for omissions or errors. Order records are updated.
7. Dispatch the shipment. Orders are packaged, shipping documents prepared, and
goods loaded on the right vehicle.
8. Operate an information system. A record must be maintained for each item in
stock showing the quantity on hand, quantity received, quantity issued, and
location in the warehouse. The system can be very simple, depending on a minimum of written information and human memory, or it may be a sophisticated
computer-based system.
In various ways, all these activities take place in any warehouse. The complexity
depends on the number of SKUs handled, the quantities of each SKU, and the number of orders received and filled. To maximize productivity and minimize cost, warehouse management must work with the following:
1. Maximum use of space. Usually the largest capital cost is for space. This means
not only floor space but cubic space as well since goods are stored in the space
above the floor as well as on it.
2. Effective use of labor and equipment. Materials handling equipment represents
the second-largest capital cost and labor the largest operating cost. There is a
trade-off between the two in that labor costs can be reduced by using more
materials handling equipment. Warehouse management will need to:
• Select the best mix of labor and equipment to maximize the overall productivity of the operation.
• Provide ready access to all SKUs. The SKUs should be easy to identify and
find. This requires a good stock location system and layout.
• Move goods efficiently. Most of the activity that goes on in a warehouse is
materials handling: the movement of goods into and out of stock locations.
Several factors influence effective use of warehouses. Some are:
•
•
•
•
Cube utilization and accessibility.
Stock location.
Order picking and assembly.
Packaging.
With the exception of packaging, these are discussed in the following sections.
Cube Utilization and Accessibility
Goods are stored not just on the floor, but in the cubic space of the warehouse.
Although the size of a warehouse can be described as so many square feet, warehouse
capacity depends on how high goods can be stored.
Space is also required for aisles, receiving and shipping docks, offices, and order
picking and assembly. In calculating the space needed for storage, some design figure
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Figure 12.1 Cube utilization.
120'
4'
Aisle
4'
for maximum inventory is needed. Suppose that a maximum of 90,000 cartons is to be
inventoried and 30 cartons fit on a pallet. Space is needed for 3000 pallets. If pallets
are stacked three high, 1000 pallet positions are required. A pallet is a platform usually measuring 48″ × 40″ × 4″.
Pallet positions. Suppose a section of a warehouse is as shown in Figure 12.1.
Since the storage area is 48″ deep, the 40″ side is placed along the wall. The pallets
cannot be placed tight against one another; a 2″ clearance must be allowed between
them so they can be moved. This then leaves room for (120′ × 12″) ÷ 42″ = 34.3, or
34, pallet positions along each side of the aisle. Since the pallets are stacked three
high, there is room for 34 × 3 × 2 = 204 pallets.
EXAMPLE PROBLEM
A company wants to store an SKU consisting of 13,000 cartons on pallets each containing 30 cartons. How many pallet positions are needed if the pallets are stored
three high?
Answer
Number of pallets required = 13,000 , 30 = 433.33 : 434 pallets
Number of pallet positions = 434 , 3 = 144.67 : 145 pallet positions
Notice one pallet position will contain only two pallets.
Accessibility. Accessibility means being able to get at the goods wanted with a
minimum amount of work. For example, if no other goods had to be moved to reach
an SKU, the SKU would be 100% accessible. As long as all pallets contain the same
SKU, there is no problem with accessibility. The SKU can be reached without moving
any other product. When several SKUs are stored in the area, each product should be
accessible with a minimum of difficulty.
Cube utilization. Suppose items are stacked along a wall, as shown in Figure 12.2.
There will be excellent accessibility for all items except item 9, but cube utilization is
not maximized. Cube utilization is the use of space horizontally and vertically.
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Physical Inventory and Warehouse Management
Figure 12.2 Cube utilization versus accessibility.
1
1
1
1
1
1
2
2
2
3
3
3
4
4
4
5
6
7
8
10
9
There is room for 30 pallets, but only 21 spaces are being used for a cube utilization
of 70% (21 ÷ 30 × 100). Some method must be devised to increase cube utilization
and maintain accessibility. One way is to install tiers of racks so lower pallets can be
removed without disturbing the upper ones. This represents a trade-off between the
capital cost of the racking and the savings in the operating cost of extra handling.
Whether the additional cost is worthwhile will depend on the amount of handling and
the savings involved.
EXAMPLE PROBLEM
A small warehouse stores five different SKUs in pallet loads. If pallets are stacked
three high and there is to be 100% accessibility, how many pallet positions are
needed? What is the cube utilization?
SKU A
SKU B
SKU C
SKU D
SKU E
Total
4 pallets
6 pallets
14 pallets
8 pallets
5 pallets
37 pallets
Answer
SKU
A: 4 pallets
B: 6 pallets
C: 14 pallets
D: 8 pallets
E: 5 pallets
Total
Pallet positions
2
2
5
3
2
14
In 14 pallet positions, there is room to store 14 × 3 = 42 pallets.
Number of pallets actually stored = 37
Cube utilization = 37 , 42 * 100% = 88%
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Stock Location
Stock location, or warehouse layout, is concerned with the location of individual
items in the warehouse. There is no single universal stock location system suitable for
all occasions, but there are a number of basic systems that can be used. Which system,
or mix of systems, is used depends on the type of goods stored, the type of storage
facilities needed, the throughput, and the size of orders. Whatever the system, management must maintain enough inventory of safety and working stock to provide the
required level of customer service, keep track of items so they can be found easily,
and reduce the total effort required to receive goods, store them, and retrieve them
for shipment.
The following are some basic systems of locating stock:
• Group functionally related items together. Group together items similar in their
use (functionally related). For example, put all hardware items in the same area
of the warehouse. If functionally related items are ordered together, order picking is easier. Warehouse personnel become familiar with the locations of items.
• Group fast-moving items together. If fast-moving items are placed close to
the receiving and shipping area, the work of moving them in and out of storage
is reduced. Slower-moving items can be placed in more remote areas of the
warehouse.
• Group physically similar items together. Physically similar items often require
their own particular storage facilities and handling equipment. Small packaged
items may require shelving whereas heavy items, such as tires or drums, require
different facilities and handling equipment. Frozen foods need freezer storage
space.
• Locate working stock and reserve stock separately. Relatively small quantities of
working stock—stock from which withdrawals are made—can be located close
to the marshalling and shipping area whereas reserve stock used to replenish
the working stock can be located more remotely. This allows order picking to
occur in a compact area and replenishment of the working stock in bulk by pallet or container load.
There are two basic systems for assigning specific locations to individual stock
items: fixed location and floating location. Either system may be used with any of the
location systems cited in the preceding paragraphs.
Fixed location. In a fixed-location system, an SKU is assigned a permanent location or locations, and no other items are stored there. This system makes it possible
to store and retrieve items with a minimum of record keeping. In some small, manual
systems, no records are kept at all. It is like always keeping cornflakes on the same
shelf in the kitchen cupboard at home. Everything is nice and simple so things are
readily found. However, fixed-location systems usually have poor cube utilization. If
demand is uniform, presumably the average inventory is half the order quantity, and
enough space has to be allocated for a full-order quantity. On the average, only 50%
Physical Inventory and Warehouse Management
341
of the cube space is utilized. Fixed-location systems are often used in small warehouses where space is not at a premium, where throughput is small, and where there
are a few SKUs.
Floating location. In a floating-location system, goods are stored wherever there
is appropriate space for them. The same SKU may be stored in several locations at
the same time and different locations at different times. The advantage to this system
is improved cube utilization. However, it requires accurate and up-to-date information on item location and the availability of empty storage space so items can be put
away and retrieved efficiently. Modern warehouses using floating-location systems
are usually computer based. The computer assigns free locations to incoming items,
remembers what items are on hand and where they are located, and directs the order
picker to the right location to find the item. Thus, cube utilization and warehouse
efficiency are greatly improved.
Point-of-use storage. Sometimes, particularly in repetitive manufacturing and
in a JIT environment, inventory is stored close to where it will be used. There are
several advantages to point-of-use storage.
•
•
•
•
Materials are readily accessible to users.
Material handling is reduced or eliminated.
Central storage costs are reduced.
Material is accessible at all times.
This method is excellent as long as inventory is kept low and operating
personnel can keep control of inventory records. Sometimes C items are issued
as “floor stock” where manufacturing is issued a large quantity which is used
as needed. Inventory records are adjusted when the stock is issued, not when it
is used.
Central storage. As opposed to point-of-use storage, central storage contains all
inventory in one central location. There are several advantages:
•
•
•
•
Ease of control.
Inventory record accuracy is easier to maintain.
Specialized storage can be used.
Reduced safety stock, since users do not need to carry their own safety stock.
Order Picking and Assembly
Once an order is received, the items on the order must be retrieved from the warehouse, assembled, and prepared for shipment. All these activities involve labor and
the movement of goods. The work should be organized to provide the level of
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customer service required and at least cost. There are several systems that can be
used to organize the work, among which are the following:
1. Area system. The order picker circulates throughout the warehouse selecting the
items on the order, much as a shopper would in a supermarket. The items are
then taken to the shipping area for shipment. The order is self-marshalling in
that when the order picker is finished, the order is complete. This system is generally used in small warehouses where goods are stored in fixed locations.
2. Zone system. The warehouse is divided into zones, and order pickers work only
in their own area. An order is divided up by zone, and each order picker selects
those items in their zone and sends them to the marshalling area where the
order is assembled for shipment. Each order is handled separately and leaves
the zone before another is handled.
Zones are usually established by grouping together related parts. Parts
may be related because of the type of storage needed for them (for example,
freezer storage) or because they are often ordered together.
A variation of the zone system is to have the order move to the next zone
rather than to the marshalling area. By the time it exits the last zone, it is
assembled for shipment.
3. Multi-order system. This system is the same as the zone system except that, rather
than handling individual orders, a number of orders are gathered together and
all the items divided by zone. The pickers then circulate through their area, collecting all the items required for that group of orders. The items are then sent to
the marshalling area where they are sorted to individual orders for shipment.
The area system is simple to manage and control, but as the warehouse
throughput and size increases, it becomes unwieldy. The zone systems break down
the order-filling process into a series of smaller areas that can be better managed
individually. The multi-order system is probably most suited to the situation in which
there are many items or many small orders with few items.
Working stock and reserve stock. In addition to the systems mentioned, reserve
stock and working stock may be separated. This is appropriate when the pick unit for a
customer’s order may be a box or a case that is stored on pallets. A pallet can be
moved into the working area by a lift truck and cartons or boxes picked from it. The
working stock is located close to the shipping area so the work in picking is reduced.
A separate workforce is used to replenish the working stock from the reserve stock.
PHYSICAL CONTROL AND SECURITY
Because inventory is tangible, items have a nasty habit of becoming lost, stray, or
stolen, or of disappearing in the night. It is not that people are dishonest, rather that
they are forgetful. What is needed is a system that makes it difficult for people to
make mistakes or be dishonest. There are several elements that help:
Physical Inventory and Warehouse Management
343
• A good-part numbering system. Part numbering was discussed in Chapter 4 on
material requirements planning.
• A simple, well-documented transaction system. When goods are received, issued,
or moved in any way, a transaction occurs. There are four steps in any transaction: identify the item, verify the quantity, record the transaction, and physically
execute the transaction.
1. Identify the item. Many errors occur because of incorrect identification.
When receiving an item, the purchase order, part number, and quantity
must be properly identified. When goods are stored, the location must be
accurately specified. When issued, the quantity, location, and part number
must be recorded.
2. Verify quantity. Quantity is verified by a physical count of the item by weighing or by measuring. Sometimes standard-sized containers are useful in
counting.
3. Record the transaction. Before any transaction is physically carried out, all
information about the transaction must be recorded.
4. Physically execute the transaction. Move the goods in, about, or out of the
storage area.
Limited access. Inventory must be kept in a safe, secure place with limited
general access. It should be locked except during normal working hours. This is less
to prevent theft than to ensure people do not take things without completing the
transaction steps. If people can wander into the stores area at any time and take
something, the transaction system fails.
A well-trained workforce. Not only should the stores staff be well trained
in handling and storing material and in recording transactions, but other personnel who interact with stores must be trained to ensure transactions are recorded
properly.
INVENTORY RECORD ACCURACY
The usefulness of inventory is directly related to its accuracy. Based on the inventory record, a company determines net requirements for an item, releases orders
based on material availability, and performs inventory analysis. If the records are
not accurate, there will be shortages of material, disrupted schedules, late deliveries, lost sales, low productivity, and excess inventory (of the wrong things).
These three pieces of information must be accurate: part description (part
number), quantity, and location. Accurate inventory records enable firms to:
• Operate an effective materials management system. If inventory records are inaccurate, gross-to-net calculations will be in error.
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• Maintain satisfactory customer service. If records show an item is in inventory
when it is not, any order promising that item will be in error.
• Operate effectively and efficiently. Planners can plan, confident that the parts will
be available.
• Analyze inventory. Any analysis of inventory is only as good as the data it is based on.
Inaccurate inventory records will result in:
•
•
•
•
•
•
Lost sales.
Shortages and disrupted schedules.
Excess inventory (of the wrong things).
Low productivity.
Poor delivery performance.
Excessive expediting, since people will always be reacting to a bad situation
rather than planning for the future.
Causes of Inventory Record Errors
Poor inventory record accuracy can be caused by many things, but they all result from
poor record-keeping systems and poorly trained personnel. Some examples of causes
of inventory record error are:
•
•
•
•
Unauthorized withdrawal of material.
Unsecured stockroom.
Poorly trained personnel.
Inaccurate transaction recording. Errors can occur because of inaccurate piece
counts, unrecorded transactions, delay in recording transactions, inaccurate
material location, and incorrectly identified parts.
• Poor transaction recording systems. Most systems today are computer based
and can provide the means to record transactions properly. Errors, when
they occur, are usually the fault of human input to the system. The documentation reporting system should be designed to reduce the likelihood of
human error.
• Lack of audit capability. Some program of verifying the inventory counts and
locations is necessary. The most popular one today is cycle counting, discussed
in the next section.
Measuring Inventory Record Accuracy
Inventory accuracy ideally should be 100%. Banks and other financial institutions
reach this level. Other companies can move toward this potential.
Figure 12.3 shows 10 inventory items, their physical count, and the quantity
shown on their record. What is the inventory accuracy? The total of all items is the
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Physical Inventory and Warehouse Management
Part Number
Inventory
Record
Shelf Count
1
100
105
2
100
100
3
100
98
4
100
97
5
100
102
6
100
103
7
100
99
8
100
100
9
100
97
10
100
99
Total
1000
1000
Figure 12.3 Inventory record accuracy.
same, but only 2 of the 10 items are correct. Is the accuracy 100% or 20% or something else?
Tolerance. To judge inventory accuracy, a tolerance level for each part must be
specified. For some items, this may mean no variance; for others, it may be very difficult or costly to measure and control to 100% accuracy. An example of the latter
might be nuts or bolts ordered and used in the thousands. For these reasons, tolerances are set for each item. Tolerance is the amount of permissible variation between
an inventory record and a physical count.
Tolerances are set on individual items based on value, critical nature of the
item, availability, lead time, ability to stop production, safety problems, or the difficulty of getting precise measurement.
Figure 12.4 shows the same data as the previous figure but includes tolerances.
This information tells us exactly what inventory accuracy is.
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Part
Number
Inventory
Record
Shelf
Count
Tolerance
Within
Tolerance
1
100
105
±5%
X
2
100
100
±0%
X
3
100
98
±3%
X
4
100
97
±2%
5
100
102
±2%
6
100
103
±2%
7
100
99
±3%
X
8
100
100
±0%
X
9
100
97
±5%
X
10
100
99
±5%
X
Total
1000
1000
Outside
Tolerance
X
X
X
Figure 12.4 Inventory accuracy with tolerances.
EXAMPLE PROBLEM
Determine which of the following items are within tolerance. Item A has a tolerance
of ±5%; item B, ±2%; item C, ±3%; and item D, ±0%.
Part
Number
Shelf
Count
Inventory
Record
Tolerance
A
1500
1550
±5 %
B
120
125
±2 %
C
225
230
±3 %
D
155
155
±0 %
Physical Inventory and Warehouse Management
347
Answer
Item A.
With a tolerance of ±5%, variance can be up to ±75 units.
Item A is within tolerance.
Item B.
With a tolerance of ±2%, variance can be up to ±2 units.
Item B is outside tolerance.
Item C.
With a tolerance of ±3%, variance can be up to ±7 units.
Item C is within tolerance.
Item D.
With a tolerance of ±0%, variance can be up to ±0 units.
Item D is within tolerance.
Auditing Inventory Records
Errors occur, and they must be detected so inventory accuracy is maintained. There
are two basic methods of checking the accuracy of inventory records: periodic (usually annual) counts of all items and cyclic (usually daily) counts of specified items. It
is important to audit record accuracy, but it is more important to audit the system to
find the causes of record inaccuracy and eliminate them. Cycle counting does this;
periodic audits tend not to.
Periodic (annual) inventory. The primary purpose of a periodic (annual) inventory is to satisfy the financial auditors that the inventory records represent the value
of the inventory. To planners, the physical inventory represents an opportunity to correct any inaccuracies in the records. Whereas financial auditors are concerned with
the total value of the inventory, planners are concerned with item detail.
The responsibility for taking the physical inventory usually rests with the materials manager who should ensure that a good plan exists and it is followed. George
Plossl once said that taking a physical inventory was like painting; the results depend
on good preparation.1 There are three factors in good preparation: housekeeping,
identification, and training.
Housekeeping. Inventory must be sorted and the same parts collected together so they
can easily be counted. Sometimes items can be precounted and put into sealed cartons.
Identification. Parts must be clearly identified and tagged with part numbers. This
can, and should, be done before the inventory is taken. Personnel who are familiar
with parts identification should be involved and all questions resolved before the
physical inventory starts.
Training. Those who are going to do the inventory must be properly instructed and
trained in taking inventory. Physical inventories are usually taken once a year, and the
procedure is not always remembered from year to year.
1. George W. Plossl, Production and Inventory Control, Principles and Techniques, 2nd ed., Appendix VI:
Physical Inventory Techniques. Englewood Cliffs, NJ: Prentice Hall, 1985.
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Process. Taking a physical inventory consists of four steps:
1. Count items and record the count on a ticket left on the item.
2. Verify this count by recounting or by sampling.
3. When the verification is finished, collect the tickets and list the items in each
department.
4. Reconcile the inventory records for differences between the physical count and
inventory dollars. Financially, this step is the job of accountants, but materials
personnel are involved in adjusting item records to reflect what is actually on
hand. If major discrepancies exist, they should be checked immediately.
Taking a physical inventory is a time-honored practice in many companies mainly
because it has been required for an “accurate” appraisal of inventory value for the
annual financial statements. However, taking an annual physical inventory presents
several problems. Usually the factory has to be shut down, thus losing production; labor
and paperwork are expensive; the job is often done hurriedly and poorly since there is
much pressure to get it done and the factory running again. In addition, the people
doing the inventory are not used to the job and are prone to making errors. As a result,
more errors often are introduced into the records than are eliminated.
Because of these problems, the idea of cycle counting has developed.
Cycle counting. Cycle counting is a system of counting inventory continually
throughout the year. Physical inventory counts are scheduled so that each item is
counted on a predetermined schedule. Depending on their importance, some items
are counted frequently throughout the year whereas others are not. The idea is to
count selected items each day.
The advantages to cycle counting are:
• Timely detection and correction of problems. The purpose of the count is first
to find the cause of error and then to correct the cause so the error is less likely
to happen again.
• Complete or partial reduction of lost production.
• Use of personnel trained and dedicated to cycle counting. This provides experienced inventory takers who will not make the errors “once-a-year” personnel
do. Cycle counters are also trained to identify problems and to correct them.
Count frequency. The basic idea is to count some items each day so all items are
counted a predetermined number of times each year. The number of times an item is
counted in a year is called its count frequency. For an item, the count frequency
should increase as the value of the item and number of transactions (chance of error)
increase. Several methods can be used to determine the frequency. Three common
ones are the ABC method, zone method, and location audit system.
• ABC method. This is a popular method. Inventories are classified according to
the ABC system (refer to Chapter 10). Some rule is established for count
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Physical Inventory and Warehouse Management
Classification
Number
of Items
Count
Frequency
per Year
A
B
C
1000
1500
2500
12
4
1
Number
% of Total
of Counts
Counts
per Year
12,000
6,000
2,500
Total counts per year
Workdays per year
Counts per day
Counts
per Day
58.5
29.3
12.2
48
24
10
20,500
250
82
Figure 12.5 Scheduling cycle counts.
frequency. For example, A items might be counted weekly or monthly; B items,
bimonthly or quarterly; and C items, biannually or once a year. On this basis, a
count schedule can be established. Figure 12.5 shows an example of a cycle
count scheduled using the ABC system.
EXAMPLE PROBLEM
A company has classified its inventory into ABC items. It has decided that A items
are to be counted once a month; B items, four times a year; and C items, twice a year.
There are 2000 A items, 3000 B items, and 5000 C items in inventory. Develop a
schedule of the counts for each class of item.
Answer
Classification
Number
of Items
Count
Frequency
per Year
A
B
C
2000
3500
5000
12
4
2
Total counts per year
Workdays per year
Counts per day
Number
% of Total
of Counts
Counts
per Year
24,000
12,000
10,000
52.2
26.1
21.7
Counts
per Day
96
48
40
46,500
250
184
• Zone method. Items are grouped by zones to make counting more efficient. The
system is used when a fixed-location system is used, or when work-in-process or
transit inventory is being counted.
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• Location audit system. In a floating-location system, goods can be stored anywhere, and the system records where they are. Because of human error, these
locations may not be 100% correct. If material is mislocated, normal cycle
counting may not find it. In using location audits, a predetermined number of
stock locations are checked each period. The item numbers of the material in
each bin are checked against inventory records to verify stock point locations.
A cycle counting program may include all these methods. The zone method is
ideal for fast-moving items. If a floating-location system is used, a combination of
ABC and location audit is appropriate.
When to count. Cycle counts can be scheduled at regular intervals or on special occasions. Some selection criteria are:
• When an order is placed. Items are counted just before an order is placed. This
has the advantage of detecting errors before the order is placed and reducing
the amount of work by counting at a time when stock is low.
• When an order is received. Inventory is at its lowest level.
• When the inventory record reaches zero. Again, this method has the advantage of
reducing work.
• When a specified number of transactions have occurred. Errors occur when transactions occur. Fast-moving items have more transactions and are more prone to error.
• When an error occurs. A special count is appropriate when an obvious error is
detected. This may be a negative balance on the stock record or when no items
can be found although the record shows some in stock.
TECHNOLOGY APPLICATIONS
Most imbalances in inventory records are caused by human error. Reading stock
codes and entering count quantities can be a source of many errors in any transaction,
including during the audit itself. Bar codes can reduce this error as they are machinereadable symbols and are widely used to gather information at all levels of retailing,
distribution, and manufacturing. The error rate for this method is extremely low compared to human error, which is estimated to be as high as 3% for repetitive entries.
The codes are standardized by industry and are usually printed on a paper label or
tag. Typically they only contain a unique identifier, such as part number, which can be
referred to a database for further information, such as price or description, as
required. The automotive industry requires labels designed to their specifications for
layout and the type of code used. These labels will include, in addition to the product
code, the manufacturer, package quantity, date of manufacture, and so forth.
Bar codes are read using a laser light, which picks up the reflection from the
bars and spaces on the label and is usually read from a short distance, although range
is improving with new designs. The use of bar codes improves the speed of data entry
but, more importantly, improves the accuracy of the data retrieved.
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Physical Inventory and Warehouse Management
Radio frequency identification (RFID) works in a way similar to bar codes, but
rather than light it uses reflected radio waves from a small device or tag to receive its
information. Unlike bar codes, RFID devices do not require a line of sight between
the label and the reader and can accurately identify products that are within containers or otherwise hidden from view. This feature makes RFID suited for use as a security device or under conditions where labels are hard to read or access. RFID tags are
more costly than printed bar codes, but the price is falling rapidly, encouraging their
use in wider applications. Major retailers such as Wal-Mart see the value in this
method of gathering information and are demanding its use in many of their products, further reducing costs throughout the supply chain.
KEY TERMS
Pallet positions 338
Accessibility 338
Cube utilization 338
Working stock 340
Reserve stock 340
Fixed-location system 340
Floating-location system 341
Point-of-use storage 341
Central storage 341
Limited access 343
Tolerance 345
Periodic (annual)
inventory 347
Cycle counting 348
Count frequency 348
QUESTIONS
1. What are four objectives of warehouse operation?
2. Describe the eight warehouse activities as they would apply to a supermarket. Include in
your description where each activity takes place and who performs the activity.
3. What are cube utilization and accessibility?
4. Why is stock location important in a warehouse? Name and describe four basic systems
of stock location and give examples of each system from a retail setting.
5. Describe fixed and floating systems for assigning locations to SKUs.
6. Name and describe three order-picking systems.
7. What are three prime objectives of materials handling? Describe the characteristics of
conveyors, industrial trucks, and cranes.
8. What are the four steps in any transaction?
9. What are some of the results of poor inventory accuracy?
10. Six causes of poor inventory accuracy are discussed in the text. Name and describe each.
11. How should inventory accuracy be measured? What is tolerance? Why is it necessary?
12. What is the basis for setting tolerance?
13. What are the two major purposes of auditing inventory accuracy?
14. In taking a physical inventory, what are the three factors in preparation? Why is good
preparation essential?
15. What are the four steps in taking a physical inventory?
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Chapter 12
16. Describe cycle counting. On what basis can the count frequency be determined?
17. Why is cycle counting a better way to audit inventory records than an annual physical
inventory?
18. When are some good times to count inventory?
PROBLEMS
12.1 A company wants to store an SKU consisting of 5000 cartons on pallets each containing
30 cartons. They are to be stored three high in the warehouse. How many pallet positions
are needed?
Answer. 56 pallet positions
12.2 A company has 7000 cartons to store on pallets. Each pallet takes 30 cartons, and the
cartons are stored four high. How many pallet positions are needed?
12.3 A company has an area for storing pallets as shown in the following diagram. How many pallets measuring 48″ × 40″ can be stored three high if there is a 2″ space between the pallets?
200'
4'
Aisle
4'
Answer. 342 pallets
12.4 A company has a warehouse with the dimensions shown in the following diagram. How
many pallets measuring 48″ × 40″ can be stored three high if there is to be a 2″ space
between the pallets?
60'
4'
Aisle
4'
4'
Aisle
4'
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Physical Inventory and Warehouse Management
12.5 A company wishes to store the following SKUs so there is 100% accessibility. The items
are stored on pallets that can be stacked three high.
a. How many pallet positions are needed?
b. What is the cube utilization?
c. If the company bought racking for storing the pallets, how many pallet positions are
needed to give 100% accessibility?
Answer.
SKU
Number of Pallets
A
B
C
D
E
Total
5
4
4
10
14
Pallet Positions
Required
a. Pallet positions needed = 15
b. Cube utilization = 82%
c. 13 pallet positions
12.6 A company wants to store the following 10 SKUs so there is 100% accessibility. Items
are stored on pallets that are stored four high.
a. How many pallet positions are needed?
b. What is the cube utilization?
c. If the company bought racking for storing the pallets, how many pallet positions are
needed to give 100% accessibility?
SKU
Number of Pallets
A
B
C
D
E
F
G
Total
14
17
40
33
55
22
34
Pallet Positions
Required
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Chapter 12
12.7 a. Which of the following items are within tolerance?
b. What is the percent accuracy by item?
Part
Number
Shelf
Count
Inventory
Record
A
650
635
± 3%
B
1205
1205
± 0%
C
1350
1500
± 5%
D
77
80
± 5%
E
38
40
± 3%
Difference
% Difference
Tolerance
Within
Tolerance?
Total
Answer.
a. A, B, and D are within tolerance.
b. 60%
12.8 a. Which of the following items are within tolerance?
b. What is the percent accuracy by item?
Part
Number
Shelf
Count
Inventory
Record
Difference
% Difference
Tolerance
A
75
80
± 3%
B
120
120
± 0%
C
1400
1500
± 5%
D
75
76
± 5%
E
68
66
± 2%
Total
Within
Tolerance?
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Physical Inventory and Warehouse Management
12.9 A company does an ABC analysis of its inventory and calculates that out of 5000 items
22% can be classified as A items, 33% as B items, and the remainder as C items. A decision is made that A items are to be cycle counted once a month, B items every 3 months,
and C items twice a year. Calculate the total counts and the counts per day by classification. The company works 5 days per week and 50 weeks per year.
Classification
Number
of Items
Count
Frequency
per Year
Number
of Counts
per Year
% of Total
Counts
Counts
per Day
A
B
C
Total counts per year
Work days per year
Total counts per day
Counts per day A = 53; B = 26; C = 18
Answer.
12.10 A company does an ABC analysis of its inventory and calculates that out of 10,000 items
19% can be classified as A items, 30% as B items, and the remainder as C items. A decision is made that A items are to be cycle counted twice a month, B items every 3 months,
and C items once a year. Calculate the total counts and the counts per day by classification. There are 250 working days per year.
Classification
Number
of Items
A
B
C
Total counts per year
Work days per year
Total counts per day
Count
Frequency
per Year
Number
of Counts
per Year
% of Total
Counts
Counts
per Day
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Chapter 12
COSTMART WAREHOUSE
Amy Gordon could not have been more pleased when she was first appointed as the
new inventory management supervisor for the CostMart regional warehouse. She had
previously worked part time as a clerk in the local CostMart Department Store while
she finished her university degree. After she got the degree, she was named as the
section head in charge of roughly one-fourth of the store. Now, a year later, she
started to wonder about that old adage, “Be careful what you ask for—you just might
get it.”
Background
One constant problem Amy had complained about when she was head clerk was the
difficulties she had with the warehouse replenishing supplies for her areas of responsibility. She was sure the problem was not hers. The store used point-of-sale terminals,
in which the cash register doubled as a computer, instantly recognizing inventory
movement. She also realized that shoplifting and other forms of loss were a constant
problem in retail stores, so she instructed all her clerks to spot count inventory in their
areas of responsibility whenever there was a “lull” in store traffic. The store computer
had a built-in program to suggest replenishment orders when the stock reduced to a
certain quantity. Amy had learned, of course, that these were only suggestions, since
she knew that some items were “faddish” and would have to be ordered sooner or not
reordered at all depending on how the fad was progressing. Some items were seasonal
in nature, which needed to be accommodated, and she was also aware when an item
would go on sale or have a special promotional campaign. These were announced well
in advance during the monthly managerial meetings, and she had good estimates as to
the projected impact on demand.
It was because she was so effective at managing the inventory in her area that
she was so vocal about the problems at the warehouse. It seemed that almost everything she ordered for replenishment from the warehouse was a problem. Some items
were late, occasionally by as many as six weeks. Other items were replenished in
quantities far larger or smaller than what was ordered, even if they were occasionally
delivered on time. It finally seemed to her that every warehouse delivery was a random event instead of the accurate filling of her orders. Her complaints to general
management stemmed from the impact of the warehouse problems. Customers in her
area were complaining more often and louder as stockouts of various items became a
pattern. Several customers had vowed to never again shop at CostMart because of
their frustration. One customer even physically dragged Amy over to the sign above
the entrance to the store—the one that proclaims “CostMart—Where Customer
Service Is in Charge”—and suggested that she could be sued for false advertising.
In other cases, the quantity delivered was two to three times the amount she
ordered. She would often have to hold special “unannounced sales” to avoid being
burdened with the excessive inventory, especially since one of her performance
metrics was inventory dollars. Of course, one of the major performance metrics was
Physical Inventory and Warehouse Management
357
profitability, and both the stockouts and unannounced sales impacted that adversely.
Finally, after one particularly frustrating day, she told the general manager, “Maybe
you should put me in charge of the inventory over at the warehouse. I can control my
own area here—I bet I could put that place back in shape pretty fast!” Two weeks
later, she was notified she was “promoted” to inventory management supervisor for
the warehouse.
The Current Situation
One of the first issues Amy faced was some not-so-subtle resentment from the warehouse general supervisor, Henry “Hank” Anderson. Hank had been a supervisor for
over 10 years, having worked his way up from an entry-level handler position. The
inventory supervisor position had been created specifically for Amy—Hank had previously had responsibility for the inventory. Their mutual boss had explained to Hank
that the reduction in overall responsibility was not a demotion, in that growth in the
warehouse made splitting the responsibilities a necessity. Although Hank outwardly
acknowledged the explanation, everyone knew that in reality he felt the change was a
“slap in the face.” That would normally be enough to cause some potential resentment, but in addition, as Hank expressed in the lunchroom one day, “It’s not enough
that they take some of my job away, but then look who they give it to—a young, inexperienced college kid, and a female at that! Everyone knows you can’t learn how to
run a warehouse in some stupid college classroom—you have to live it and breathe it
to really understand it.”
Amy knew that the Hank situation was one she would have to work on, but in
the meantime she had to understand how things were run, and specifically why the
warehouse was causing all the problems she experienced at the store. Her first stop
was to talk to Jane Dawson, who was responsible for processing orders from the
store. Jane explained the situation from her perspective.
“I realize how much it must have bothered you to see how your store requests
were processed here, but it frustrates me too. I tried to group orders to prioritize due
dates and still have a full truckload to send to the store, but I was constantly having
problems thrown back at me. Sometimes I was told the warehouse couldn’t find the
inventory. Other times I was told that the quantity you ordered was less than a full
box, and they couldn’t (or wouldn’t) split the box up, so they were sending the full
box. Then they would find something they couldn’t find when it was ordered a long
time ago, so now that they found it they were sending it. That order would, of course,
take up so much room in the truck that something else had to be left behind to be
shipped later. Those problems, in combination with true inventory shortages from
supplier-missed shipments always seems to put us behind and never able to ship what
we are supposed to. None of this seemed to bother Hank too much. Maybe you can
do something to change the situation.”
Amy’s concern with what Jane told her was increased when she asked Jane if
she knew the accuracy of their inventory records and was told that she wasn’t sure,
but the records were probably no more than 50% accurate. How can that be? Amy
asked herself. She knew they had recently installed a new computer system to handle
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Chapter 12
the inventory, they did cycle counting on a regular basis, and they used a “home base”
storage system, where each SKU had its own designated space in the warehouse
racks. She realized she needed to talk to one of the workers. She decided on Carl
Carson, who had been with the company for about five years and had a reputation for
being a dedicated and effective worker. Amy told Carl what she already knew and
asked him if he could provide any additional information.
According to Carl, “What Jane told you is true, but what she didn’t tell you is
that a lot of it is her fault. If she would only give us some advanced warning about
what she wants to send for the next shipment we could probably do a better job of
finding the material and staging it. What happens, though, is that she gives us this
shipment list out of the blue and expects us to find it all and get it ready in very little
time. For one thing, she doesn’t understand that it’s very impractical to break boxes
apart in order to ship just the quantity she wants. We don’t have a good way to package the partial box, and an open box increases the chance for the remaining goods to
be damaged or get dirty. Even if we had a way to partially package, the time it would
take would increase the chance we wouldn’t make the shipment on time.
“Then there’s the problem of finding material. When supplier shipments come
in, they are often for more goods of a given SKU than we have room for on the rack.
We put the rest in an overflow area, but it’s really hard to keep track of. Even if we
locate it in the system correctly, someone will soon move it to get to something
behind it. That person will usually forget to record the move in the heat of getting a
shipment ready. Since the cycle counts don’t find it in the designated rack, the cycle
counters adjust the count so the system doesn’t even know it exists anymore. You
might think we should expand the space in the rack to hold the maximum amount of
each SKU, but we would need a warehouse at least double this size to do that—and
there’s no way management would approve that. I guess the only good thing about
the situation is that when we do find some lost material that was requested earlier, we
ship it to make up for not shipping it earlier.”
Amy was beginning to feel a tightening in her stomach as she realized the extent
of the problem here. She almost had to force herself to talk to Crista Chávez, who
worked for the purchasing department and was responsible for warehouse ordering.
Crista was also considered to be experienced, capable, and dedicated to doing a good
job for the company. Crista added the following perspective:
“We have good suppliers, but they’re not miracle workers. Since we beat them
up so badly on price most of the time, I can understand why they’re not interested in
doing more than they already are. The problem is we can’t seem to get our own house
in order to give them a good idea what we need and when we really need it. To do
that, we would need to know what the warehouse needs and when, and also the existing inventory of the item. We seem to have no idea what we need, and the inventory
records are a joke. I spend most of my day changing order dates, order quantities, or
expediting orders to fill a shortage—and often the shortage isn’t really a shortage at
all. Our only hope has been to order early and increase our order quantities to ensure
we have enough safety stock to cover the inventory accuracy problems. I’ve complained to Hank several times, but all he says is that it’s my job to pull the suppliers in
line, that the problem is obviously theirs.”
Physical Inventory and Warehouse Management
359
At least by this point Amy had a better perspective about the problems.
Unfortunately, it was now up to her to fix them. She wished she had never opened her
mouth to complain about the problems. Too late for that—she now had to develop a
strategy to deal with what she had been handed.
Case Analysis
1. Structure what you think the problems are. Be sure to separate the problems from the
symptoms.
2. Assume Amy needs to build a data-based case to convince her boss and start to “win
over” Hank. What data should she gather to help her build the case?
3. Develop a model of how you think the warehouse should work in this environment.
4. Develop a time-phased plan to move from the present situation to the model you developed in question 3.
13
Physical Distribution
INTRODUCTION
Chapter 1 introduced the supply chain concept. It was pointed out that a supply chain
is composed of a series of suppliers and customers linked together by a physical distribution system. Usually the supply chain consists of several companies linked in this
way. This chapter will discuss the physical distribution aspect of supply chains.
Channels of distribution cover the physical movement of goods as well as the change
of ownership that occurs throughout the supply chain. The physical distribution system involves the transportation of goods through the various modes, the inventories
that exist in transit and in distribution centers, the physical handling of goods, and the
need for protective packaging. Multiple warehouse decisions involve the costs associated with adding more warehouses and the effect on customer service.
Physical distribution is the movement of materials from the producer to the
consumer. It is the responsibility of the distribution department, which is part of an
integrated materials management or logistics system. Figure 13.1 shows the relationship of the various functions in this type of system.
In Figure 13.1, the movement of materials is divided into two functions: physical supply and physical distribution. Physical supply is the movement and storage of
goods from suppliers to manufacturing. Depending on the conditions of sale, the cost
may be paid by either the supplier or the customer, but it is ultimately passed on to
the customer. Physical distribution, on the other hand, is the movement and storage
of finished goods from the end of production to the customer. The particular path in
360
361
Physical Distribution
S
U
P
P
L
I
E
R
MANUFACTURER
Physical
Supply
Manufacturing
Planning and
Control
DISTRIBUTION
SYSTEM
C
U
S
T
O
M
E
R
Physical Distribution
DOMINANT FLOW OF PRODUCTS AND SERVICES
DOMINANT FLOW OF DEMAND AND DESIGN INFORMATION
Figure 13.1 Supply chain (logistics system).
which the goods move—through distribution centers, wholesalers, and retailers—is
called the channel of distribution.
Channels of Distribution
A channel of distribution is one or more companies or individuals who participate in the
flow of goods and/or services from the producer to the final user or consumer. Sometimes
a company delivers directly to its customers, but often it uses other companies or individuals to distribute some or all of its products to the final consumer. These companies
or individuals are called intermediaries. Examples of intermediaries are wholesalers,
agents, transportation companies, and warehousers.
There are really two related channels involved. The transaction channel is concerned with the transfer of ownership. Its function is to negotiate, sell, and contract.
The distribution channel is concerned with the transfer or delivery of the goods or
services. The same intermediary may perform both functions, but not necessarily.
Figure 13.2 shows an example of the separation of distribution and transaction
channels. The example might be for a company distributing a major appliance such as
a refrigerator or stove. In such a system the retailer usually carries only display models. When the customer orders an appliance, delivery is made from either the
regional warehouse or the public warehouse.
In this text we are concerned with the distribution channel.
Although it can be argued that one firm’s physical supply is another firm’s physical distribution, frequently there are important differences, particularly as they
relate to the bulk and physical condition of raw materials and finished goods. The
logistics problems that occur in moving and storing iron ore are quite different from
those that occur in moving sheet steel. These differences influence the design of a
logistics system and are important in deciding the location of distribution centers and
factories. This text refers to both physical distribution and physical supply as physical
distribution, but the differences for any particular company should be remembered.
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DISTRIBUTION
CHANNEL
TRANSACTION
CHANNEL
FACTORY
WAREHOUSE
GENERAL SALES
OFFICE
REGIONAL
WAREHOUSE
DISTRICT SALES
OFFICE
PUBLIC
WAREHOUSE
DISTRIBUTOR
LOCAL
DELIVERY
RETAILER
COMPANY
TRUCK
COMMON
CARRIER
CONSUMER
Figure 13.2 Separation of distribution and transaction channels.
Physical distribution is vital in our lives. Usually, manufacturers, customers, and
potential customers are widely dispersed geographically. If manufacturers serve only
their local market, they restrict their potential for growth and profit. By extending its
market, a firm can gain economies of scale in manufacturing, reduce the cost of purchases by volume discounts, and improve its profitability. However, to extend markets requires a well-run distribution system. Manufacturing adds form value to a
product by taking the raw materials and creating something more useful. Bread is
made from grain and is far more useful to humans than the grain itself. Distribution
adds place value and time value by placing goods in markets where they are available
to the consumer at the time the consumer wants them.
The specific way in which materials move depends upon many factors. For
example:
• The channels of distribution that the firm is using. For example, producer to
wholesaler to retailer to consumer.
• The types of markets served. Market characteristics such as the geographic dispersion of the market, the number of customers, and the size of orders.
• The characteristics of the product. For example, weight, density, fragility, and
perishability.
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• The type of transportation available to move the material. For example, trains,
ships, planes, and trucks.
All are closely related. For instance, florists selling a perishable product to a
local market will sell directly and probably use their own trucks. However, a national
canning company selling a nonperishable product to a national market through a distribution channel composed of wholesalers and retailers may use trucks and rail
transport.
Reverse Logistics
Increasingly, companies must deal with the flow of goods coming back from the final
customer or other companies in the distribution channel. This reverse flow of goods
is due to the increased quality demands of customers in the goods they purchase and
to financial pressures on distributors to reduce slow-moving or unwanted inventories.
The eleventh edition of the APICS Dictionary defines reverse logistics as a complete
supply chain dedicated to the reverse flow of products and materials for the purpose
of returns, repair, remanufacture, and/or recycling.
In some distribution channels reverse logistics can represent major costs, which
are growing partly due to the increased use of the Internet. Sales through the Internet
tend to be to a wider geographic area and have a higher-than-normal frequency of
returns. The total costs associated with reverse logistics are estimated to exceed
$50 billion per year in the United States alone. The amount of goods returned in the
publishing industry can be as high as 50% of the original shipments as magazines go out
of date, or 90% in the automotive parts industry for the rebuilding of starter motors
and alternators. In addition to this, companies are being forced to take responsibility
for the return of packaging. There are two main categories of reverse logistics: asset
recovery, which is the return of actual products, and green reverse logistics, which
represents the responsibility of the supplier to dispose of packaging materials or environmentally sensitive materials such as heavy metals and other restricted materials.
The costs of green reverse logistics are reduced through the use of reusable
packaging, such as bins or racks rather than corrugated containers, or an overall
reduction in the amount of packaging. Environmentally sensitive materials can be
sorted and either reused in manufacturing or disposed of in the most cost-effective
method possible, hopefully avoiding landfills. Refillable beverage containers reduce
the need for landfill space but impose a cost on the producer for sorting and handling.
Reducing costs associated with asset recovery involves coordinating the handling
of the materials perhaps with the outbound flow of new goods. Information on the
returned materials is necessary to ensure proper reuse or disposal of the materials.
If the return will generate a credit to the sender, then this will also require information.
An example of this working quite well occurs with the replacement of a starter motor
in a car. The installer orders a starter motor and installs it. The old starter motor,
which should be the same size and model as the replacement, is placed in the original
carton and sent back to the supplier for a credit. The carton will have all the information describing the motor and can be used for identification as it travels back to the
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rebuilder. To reduce costs, distributors will coordinate the outbound shipments of new
motors with the return of old motors for rebuilding.
Goods are returned for many reasons that can include:
•
•
•
•
•
•
Quality demands by final customers (both real and perceived).
Damaged or defective products.
Inventories that result from over-forecast demand.
Seasonal inventories.
Out-of-date inventories.
Remanufacturing and refurbishment of products.
Returned goods can be:
•
•
•
•
•
Returned to inventory.
Refurbished for resale.
Sold into alternate markets.
Broken down into reusable components.
Sorted to recover valuable materials (further reducing disposal costs).
If the distribution channel is very simple, as in the return of starter motors example,
organizations can reduce reverse logistics costs by coordinating outbound and
inbound shipments. Should the distribution channel, however, be very complex,
third-party logistics companies (3PLs) can be used to centralize the handling and disposition of the returned goods and to provide the information to track the flow of the
goods. Companies that take a strategic approach to reverse logistics can recover
significant costs and provide better inventory levels throughout the supply chain.
These companies will also build reputations as good corporate citizens.
PHYSICAL DISTRIBUTION SYSTEM
Physical distribution is responsible for delivering to the customer what is wanted on
time and at minimum cost. The objective of distribution management is to design and
operate a distribution system that attains the required level of customer service and
does so at least cost. To reach this objective, all activities involved in the movement
and storage of goods must be organized into an integrated system.
Activities in the Physical Distribution System
A system is a set of components or activities that interact with each other. A car
engine is a system; if any part malfunctions, the performance of the whole engine
suffers. In a distribution system, six interrelated activities affect customer service and
the cost of providing it:
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365
1. Transportation. Transportation involves the various methods of moving goods
outside the firm’s buildings. For most firms, transportation is the single highest
cost in distribution, usually accounting for 30% to 60% of distribution costs.
Transportation adds place value to the product.
2. Distribution inventory. Distribution inventory includes all finished goods inventory at any point in the distribution system. In cost terms, it is the second most
important item in distribution, accounting for about 25% to 30% of the cost of
distribution. Inventories create time value by placing the product close to the
customer.
3. Warehouses (distribution centers). Warehouses are used to store inventory.
The management of warehouses makes decisions on site selection; number of
distribution centers in the system; layout; and methods of receiving, storing, and
retrieving goods.
4. Materials handling. Materials handling is the movement and storage of goods
inside the distribution center. The type of materials handling equipment used
affects the efficiency and cost of operating the distribution center. Materials
handling represents a capital cost, and a trade-off exists between this capital
cost and the operating costs of the distribution center.
5. Protective packaging. Goods moving in a distribution system must be contained,
protected, and identified. In addition, goods are moved and stored in packages
and must fit into the dimension of the storage spaces and the transportation
vehicles.
6. Order processing and communication. Order processing includes all activities
needed to fill customer orders. Order processing represents a time element in
delivery and is an important part of customer service. Many intermediaries are
involved in the movement of goods, and good communication is essential to a
successful distribution system.
Total-Cost Concept
The objective of distribution management is to provide the required level of customer service at the least total system cost. This does not mean that transportation
costs or inventory costs or any one activity cost should be a minimum but that the
total of all costs should be a minimum. What happens to one activity has an effect on
other activities, total system cost, and the service level. Management must treat the
system as a whole and understand the relationships among the activities.
EXAMPLE PROBLEM
A company normally ships a product by rail. Transport by rail costs $200, and the
transit time is 10 days. However, the goods can be moved by air at a cost of $1000 and
will take 1 day to deliver. The cost of inventory in transit for a particular shipment is
$100 per day. What are the costs involved in their decision?
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Answer
Transportation Cost
In-Transit Inventory-Carrying Cost
Total
Rail
Air
$ 200
1000
$1200
$1000
100
$1100
There are two related principles illustrated here:
1. Cost trade-off. The cost of transportation increased with the use of air transport, but the cost of carrying inventory decreased. There was a cost trade-off
between the two.
2. Total cost. By considering all of the costs and not just any one cost, the total system cost is reduced. Note also that even though no cost is attributed to it, customer service is improved by reducing the transit time. The total cost should
also reflect the effect of the decision on other departments, such as production
and marketing.
The preceding example does not mean that using faster transport always results
in savings. For example, if the goods being moved are of low value and inventory carrying cost is only $10 per day, rail will be cheaper. In addition, other costs may have to
be considered.
Most of the decisions in distribution, and indeed much of what is done in business and in our own lives, involve trade-offs and an appreciation of the total costs
involved. In this section, the emphasis is on the costs and trade-offs incurred and on
improvement in customer service. Generally, but not always, an increase in customer
service requires an increase in cost, which is one of the major trade-offs.
Global Distribution
Global distribution is the movement of goods to and from locations around the world.
Organizations are moving toward the global sourcing and selling of goods due to lower
manufacturing costs in other nations and the ability of both foreign and domestic
manufacturers to supply a global market. Global distribution of goods is similar to
movement within North America since information is needed to control inventories,
customer needs must be satisfied, and carriers depend on communications to reach
their destinations. Some differences, however, must be taken into consideration when
dealing with organizations around the world: distance, language, culture, currency, and
measurement.
The longer the distance that goods must travel, the greater the time to reach
markets. Such distances may require conducting business across different time zones.
As the goods cross borders, the languages spoken may differ for the manufacturer,
warehouse agencies, and carriers. Cultural differences can include the methods of
conducting business, the occurrence of religious holidays, and the local work ethic.
Currency exchange and international fund transfers are becoming increasingly easy;
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367
however, fluctuations in currencies can change costs dramatically and must be taken
into account when assessing the risks involved in deciding where to source goods.
Measurement systems will differ around the world, and a good example of this
is weight. A ton is 2000 pounds, a long ton is 2240 pounds, and a metric tonne is 2205
pounds. The units of measure for weight can depend on the country that is handling
the goods. Overall, global distribution can be very complicated for individuals and
companies facing this challenge.
Fortunately, technologies and systems in place now can alleviate some of these
problems. Time is less of an issue. The Internet allows companies to conduct business at
all hours of the day. With written Internet transactions, fewer misinterpretations of order
information occur such as sizes, quantities, and descriptions. International standards
help solve many distribution issues The International Organization for Standardization
(ISO, discussed in Chapter 16), for example, has established standards for ocean shipping containers that allow the seamless handling of goods from ship, to rail, to truck
across virtually all nations. Some standards have a long history. As early as 1936,
Incoterms were developed by the Paris-based International Chamber of Commerce to
provide internationally accepted regulations for trade terms such as export packing costs,
customs clearance, inland and ocean transportation costs, and damage insurance.
Global distribution will continue to grow, become easier, and increasingly allow
companies to manufacture goods at competitive rates and to sell their products in a
global market. As global distribution becomes essential, people working in distribution will need to expand their knowledge of global-based supply systems and international business practices to remain effective.
INTERFACES
By taking the goods produced by manufacturing and delivering them to the customer,
physical distribution provides a bridge between marketing and production. As such,
there are several important interfaces among physical distribution and production
and marketing.
Marketing
Although physical distribution interacts with all departments in a business, its closest
relationship is probably with marketing. Indeed, physical distribution is often thought
of as a marketing subject, not as part of materials management or logistics.
The “marketing mix” is made up of product, promotion, price, and place, and
the latter is created by physical distribution. Marketing is responsible for transferring
ownership. This is accomplished by such methods as personal selling, advertising,
sales promotion, merchandising, and pricing. Physical distribution is responsible for
giving the customer possession of the goods and does so by operating distribution
centers, transportation systems, inventories, and order processing systems. It has the
responsibility of meeting the customer service levels established by marketing and the
senior management of the firm.
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Physical distribution contributes to creating demand. Prompt delivery, product
availability, and accurate order filling are important competitive tools in promoting a
firm’s products. The distribution system is a cost, so its efficiency and effectiveness influence the company’s ability to price competitively. All of these affect company profits.
Production
Physical supply establishes the flow of material into the production process. The service level must usually be very high because the cost of interrupted production schedules caused by raw material shortage is usually enormous.
There are many factors involved in selecting a site for a factory, but an important
one is the cost and availability of transportation for raw materials to the factory and the
movement of finished goods to the marketplace. Sometimes the location of factories is
decided largely by the sources and transportation links of raw materials. This is particularly true where the raw materials are bulky and of relatively low value compared to the
finished product. The location of steel mills on the Great Lakes is a good example. The
basic raw material, iron ore, is bulky, heavy, and of low unit value. Transportation costs
must be kept low to make a steel mill profitable. Iron ore from mines in either northern
Quebec or Minnesota is transported to the mills by boat, the least costly mode of transportation. In other cases, the availability of low-cost transportation makes it possible to
locate in areas remote from markets, but where labor is inexpensive.
Unless a firm is delivering finished goods directly to a customer, demand on the
factory is created by the distribution center orders and not directly by the final customer. As noted in Chapter 11, this can have severe implications on the demand pattern at the factory. Although the demand from customers may be relatively uniform,
the factory reacts to the demand from the distribution centers for replenishment
stock. If the distribution centers are using an order point system, the demand on the
factory will not be uniform and will be dependent rather than independent. The distribution system is the factory’s customer, and the way that the distribution system
interfaces with the factory will influence the efficiency of factory operations.
TRANSPORTATION
Transportation is an essential ingredient in the economic development of any area. It
brings together raw materials for production of marketable commodities and distributes
the products of industry to the marketplace. As such, it is a major contributor to the economic and social fabric of a society and aids economic development of regional areas.
The carriers of transportation can be divided into five basic modes:
1.
2.
3.
4.
5.
Rail.
Road, including trucks, buses, and automobiles.
Air.
Water, including oceangoing, inland, and coastal ships.
Pipeline.
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Each mode has different cost and service characteristics. These determine
which method is appropriate for the types of goods to be moved. Certain types of traffic are simply more logically moved within one mode than they are in another. For
example, trucks are best suited to moving small quantities to widely dispersed markets, but trains are best suited to moving large quantities of bulky cargo such as grain.
Costs of Carriage
To provide transportation service, any carrier, whatever mode, must have certain
basic physical elements. These elements are ways, terminals, and vehicles. Each
results in a cost to the carrier and, depending on the mode and the carrier, may be
either capital (fixed) or operating (variable) costs. Fixed costs are costs that do not
change with the volume of goods carried. The purchase cost of a truck owned by the
carrier is a fixed cost. No matter how much it is used, the cost of the vehicle does not
change. However, many costs of operation, such as fuel, maintenance, and driver’s
wages, depend on the use made of the truck. These are variable costs.
Ways are the paths over which the carrier operates. They include the right-ofway (land area being used), plus any roadbed, tracks, or other physical facilities
needed on the right-of-way. The nature of the way and how it is paid for vary with the
mode. Ways may be owned and operated by the government or by the carrier or provided by nature.
Terminals are places where carriers load and unload goods to and from vehicles
and make connections between local pickup and delivery service and line-haul service. Other functions performed at terminals are weighing; connecting with other
routes and carriers; vehicle routing, dispatching, and maintenance; and administration and paperwork. The nature, size, and complexity of the terminal varies with the
mode and size of the firm and the types of goods carried. Terminals are generally
owned and operated by the carrier but, in some special circumstances, may be publicly owned and operated.
Vehicles of various types are used in all modes except pipelines. They serve as
carrying and power units to move the goods over the ways. The carrier usually owns
or leases the vehicles, although sometimes the shipper owns or leases them.
Besides ways, terminals, and vehicles, a carrier will have other costs such as
maintenance, labor, fuel, and administration. These are generally part of operating
costs and may be fixed or variable.
Rail
Railways provide their own ways, terminals, and vehicles, all of which represent a
large capital investment. This means that most of the total cost of operating a railway
is fixed. Thus, railways must have a high volume of traffic to absorb the fixed costs.
They will not want to install and operate rail lines unless there is a large enough volume of traffic. Trains move goods by trainloads composed of perhaps a hundred cars
each with a carrying capacity in the order of 160,000 pounds.
Therefore, railways are best able to move large volumes of bulky goods over
long distances. Their frequency of departure will be less than trucks, which can move
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when one truck is loaded. Rail speed is good over long distances, the service is generally reliable, and trains are flexible about the goods they can carry. Train service is
cheaper than road service for large quantities of bulky commodities such as coal,
grain, potash, and containers moved over long distances.
Road
Trucks do not provide their own ways (roads and highways) but pay a fee to the government as license, gasoline, and other taxes and tolls for the use of roads. Terminals
are usually owned and operated by the carrier but may be either privately owned or
owned by the government. Vehicles are owned, or leased, and operated by the carrier.
If owned, they are a major capital expense. However, in comparison to other modes,
the cost of a vehicle is small. This means that for road carriers most of their costs are
operating (variable) in nature.
Trucks can provide door-to-door service as long as there is a suitable surface on
which to drive. In the United States and Canada, the road network is superb. The unit of
movement is a truckload, which can be up to about 100,000 pounds. These two factors—
the excellent road system and the relatively small unit of movement—mean that trucks
can provide fast flexible service almost anywhere in North America. Trucks are particularly suited to distribution of relatively small-volume goods to a dispersed market.
Air
Air transport does not have ways in the sense of fixed physical roadbeds, but it does
require an airway system that includes air traffic control and navigation systems.
These systems are usually provided by the government. Carriers pay a user charge
that is a variable cost to them. Terminals include all of the airport facilities, most of
which are provided by the government. However, carriers are usually responsible for
providing their own cargo terminals and maintenance facilities, either by owning or
renting the space. The carrier provides the aircraft either through ownership or leasing. The aircraft are expensive and are the single most important cost element for the
airline. Since operating costs are high, airlines’ costs are mainly variable.
The main advantage of air transport is speed of service, especially over long distances. Most cargo travels in passenger aircraft, and thus many delivery schedules are
tied to those of passenger service. The service is flexible about destination provided
there is a suitable landing strip. Transportation cost for air cargo is higher than for
other modes. For these reasons, air transport is most often suitable for high-value,
low-weight cargo or for emergency items.
Water
Waterways are provided by nature or by nature with the assistance of the government.
The St. Lawrence Seaway system is an example of this. The carrier thus has no capital
cost in providing the ways but may have to pay a fee for using the waterway.
Terminals may be provided by the government but are increasingly privately
owned. In either case, the carrier will pay a fee to use them. Thus, terminals are
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371
mainly a variable cost. Vehicles (ships) are either owned or leased by the carrier and
represent the major capital or fixed cost to the carrier.
The main advantage of water transport is cost. Operating costs are low, and since
the ships have a relatively large capacity, the fixed costs can be absorbed over large volumes. Ships are slow and operate door to door only if the shipper and the consignee
are on a waterway. Therefore, water transportation is most useful for moving lowvalue, bulky cargo over relatively long distances where waterways are available.
Pipelines
Pipelines are unique among the modes of transportation in that they move only gas,
oil, and refined products on a widespread basis. As such, they are of little interest to
most users of transportation. Capital costs for ways and pipelines are high and are
borne by the carrier, but operating costs are very low.
LEGAL TYPES OF CARRIAGE
Carriers are legally classified as public (for hire) or private (not for hire). In the latter, individuals or firms own or lease their vehicles and use them to move their own
goods. Public transport, on the other hand, is in the business of hauling for others for
pay. All modes of transport have public and for-hire carriers.
For-hire carriers are subject to economic regulation by federal, state, or municipal governments. Depending on the jurisdiction, economic regulation may be more
or less severe, and in recent years, there has been a strong move by government to
reduce regulations. Economic regulation has centered on three areas:
1. Regulation of rates.
2. Control of routes and service levels.
3. Control of market entry and exit.
Private carriers are not subject to economic regulation but, like public carriers,
are regulated in such matters as public safety, license fees, and taxes.
For Hire
A for-hire carrier may carry goods for the public as a common carrier or under contract to a specified shipper.
Common carriers make a standing offer to serve the public. This means that
whatever products they offer to carry will be carried for anyone wanting their service.
With some minor exceptions, they can carry only those commodities they are licensed
to carry. For instance, a household mover cannot carry gravel or fresh vegetables.
Common carriers provide the following:
• Service available to the public.
• Service to designated points or in designated areas.
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• Scheduled service.
• Service of a given class of movement or commodity.
Contract carriers haul only for those with whom they have a specific formal
contract of service, not the general public. Contract carriers offer a service according
to a contractual agreement signed with a specific shipper. The contract specifies the
character of the service, performance, and charges.
Private
Private carriers own or lease their equipment and operate it themselves. This means
investment in equipment, insurance, and maintenance expense. A company normally
only considers operating its own fleet if the volume of transport is high enough to justify the capital expense.
Service Capability
Service capability depends on the availability of transportation service, which in turn
depends on the control that the shipper has over the transportation agency. The shipper
must go to the marketplace to hire a common carrier and is subject to the schedules
and regulations of that carrier. Least control is exercised over common carriers.
Shippers can exercise most control over their own vehicles and have the highest service
capability with private carriage.
Other Transportation Agencies
There are several transportation agencies that use the various modes or combinations
of the modes. Some of these are the post office, freight forwarders, couriers, and
shippers. They all provide a transportation service, usually as a common carrier. They
may own the vehicles, or they may contract with carriers to move their goods. Usually,
they consolidate small shipments into large shipments to make economic loads.
TRANSPORTATION COST ELEMENTS
There are four basic cost elements in transportation. Knowledge of these costs
enables a shipper to get a better price by selecting the right shipping mode. The four
basic costs are as follows:
1.
2.
3.
4.
Line haul.
Pickup and delivery.
Terminal handling.
Billing and collecting.
We will use motor transport as an example, but the principles are the same for
all modes.
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Figure 13.3 Shipping
patterns.
FULL LOAD
SHIPMENTS
S
H
I
P
P
E
R
Local
T
E
R
M
I
N
A
L
Full Load
Long Distance
T
E
R
M
I
N
A
L
Local
C
O
N
S
I
G
N
E
E
Goods move either directly from the shipper to the consignee or through a terminal. In the latter, they are picked up in some vehicle suitable for short-haul local
travel. They are then delivered to a terminal where they are sorted according to destination and loaded onto highway vehicles for travel to a destination terminal. There,
they are again sorted, loaded on local delivery trucks, and taken to the consignee.
Figure 13.3 shows this pattern schematically.
Line-Haul Costs
When goods are shipped, they are sent in a moving container that has a weight and
volume capacity. The carrier, private or for hire, has basic costs to move this container, which exist whether the container is full or not. For a truck, these include such
items as the driver’s wages and depreciation due to usage. These costs vary with the
distance traveled, not the weight carried. The carrier has essentially the same basic
costs whether the truck moves full or empty. If it is half full, the basic costs must be
spread over only those goods in the truck.
Therefore, total line-haul costs vary directly with the distance shipped, not on
the weight shipped. For example, if for a given commodity the line-haul cost is $3 per
mile and the distance is 100 miles, the total line-haul cost is $300. If the shipper sends
50,000 pounds, the total line-haul cost is the same as if 10,000 pounds is sent.
However, the line-haul costs (LHC) per hundredweight (cwt.) is different.
300
500
= $0.60 per cwt. [for 50,000 lbs. 1500 cwt.2]
300
LHC/cwt. =
100
= $3 per cwt. [for 10,000 lbs. 1100 cwt.2]
LHC/cwt. =
Thus, the total line-haul cost varies with (a) the cost per mile and (b) the distance moved. However, the line-haul cost per hundredweight varies with (a) the cost
per mile, (b) the distance moved, and (c) the weight moved.
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EXAMPLE PROBLEM
For a particular commodity, the line-haul cost is $2.50 per mile. For a trip of 500
miles and a shipment of 600 cwt., what is the cost of shipping per cwt.? If the shipment is increased to 1000 cwt., what is the saving in cost per cwt.?
Answer
Total line-haul cost = $2.5 * 500 = $1250
Cost per cwt. = $1250 , 600 = $2.083
If 1000 cwt. is shipped:
Cost per cwt. = $1250 , 1000 = $1.25
Saving per cwt. = $2.08 - $1.25 = $0.83
The carrier has two limitations or capacity restrictions on how much can be
moved on any one trip: the weight limitation and the cubic volume limitation of the
vehicle. With some commodities, their density is such that the volume limitation is
reached before the weight limitation. If the shipper wants to ship more, a method of
increasing the density of the goods must be found. This is one reason that some lightweight products are made so they nest (for example, disposable cups) and bicycles
and wheelbarrows are shipped in an unassembled state. This is not to frustrate us
poor mortals who try to assemble them but to increase the density of the product so
more weight can be shipped in a given vehicle. The same principle applies to goods
stored in distribution centers. The more compact they are, the more can be stored in
a given space. Therefore, if shippers want to reduce transportation cost, they should
(a) increase the weight shipped and (b) maximize density.
EXAMPLE PROBLEM
A company ships barbecues fully assembled. The average line-haul cost per shipment
is $12.50 per mile, and the truck carries 100 assembled barbecues. The company
decides to ship the barbecues unassembled and figures it can ship 500 barbecues in a
truck. Calculate the line-haul cost per barbecue assembled and unassembled. If the
average trip is 300 miles, calculate the saving per barbecue.
Answer
Line-haul cost assembled = $12.50 , 100 = $0.125 per barbecue per mile
Line-haul cost unassembled = $12.50 , 500 = $0.025 per barbecue per mile
Physical Distribution
Saving per mile = $0.125 - 0.025 = $0.10
Trip saving = 300 * $0.10 = $30.00 per barbecue
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375
Pickup and Delivery Costs
Pickup and delivery costs are similar to line-haul costs except that the cost depends
more on the time spent than on the distance traveled. The carrier will charge for each
pickup and the weight picked up. If a shipper is making several shipments, it will be
less expensive if they are consolidated and picked up on one trip.
Terminal Handling
Terminal-handling costs depend on the number of times a shipment must be loaded,
handled, and unloaded. If full truckloads are shipped, the goods do not need to be
handled in the terminal but can go directly to the consignee. If part loads are shipped,
they must be taken to the terminal, unloaded, sorted, and loaded onto a highway
vehicle. At the destination, the goods must be unloaded, sorted, and loaded onto a
local delivery vehicle.
Each individual parcel must be handled. A shipper who has many customers,
each ordering small quantities, will expect the terminal-handling costs to be high
because there will be a handling charge for each package.
The basic rule for reducing terminal-handling costs is to reduce handling effort
by consolidating shipments into fewer parcels.
Billing and Collecting
Every time a shipment is made, paperwork must be done and an invoice made out.
Billing and collecting costs can be reduced by consolidating shipments and reducing
the pickup frequency.
Total Transportation Costs
The total cost of transportation consists of line-haul, pickup and delivery, terminalhandling, and billing and collecting costs. To reduce shipping costs, the shipper needs
to do the following:
• Decrease line-haul costs by increasing the weight shipped.
• Decrease pickup and delivery cost by reducing the number of pickups. This can
be done by consolidating and increasing the weight per pickup.
• Decrease terminal-handling costs by decreasing the number of parcels by consolidating shipments.
• Decrease billing and collecting costs by consolidating shipments.
For any given shipment, the line-haul costs vary with the distance shipped.
However, the pickup and delivery, terminal-handling, and billing costs are fixed. The
total cost for any given shipment thus has a fixed cost and a variable cost associated
with it. This relationship is shown in Figure 13.4. The carrier will consider this relationship and either charge a fixed cost plus so much per mile or offer a tapered rate.
376
Chapter 13
COST
Figure 13.4 Distance versus
cost of carriage.
Total Cost
Fixed Cost
DISTANCE
In the latter, the cost per mile for short distances far exceeds that for longer
distances.
The rate charged by a carrier will also vary with the commodity shipped and will
depend upon the following:
• Value. A carrier’s liability for damage will be greater the more valuable the
item.
• Density. The more dense the item, the greater the weight that can be carried in
a given vehicle.
• Perishability. Perishable goods often require special equipment and methods of
handling.
• Packaging. The method of packaging influences the risk of damage and breakage.
In addition, carriers have two rate structures, one based on full loads called truckload (TL) or carload (CL) and one based on less than truckload (LTL) and less than
carload (LCL). For any given commodity, the LTL rates can be up to 100% higher than
the TL rates. The basic reason for this differential lies in the extra pickup and delivery,
terminal-handling and billing, and collection costs. Truckers, airlines, and water carriers
accept less than full loads, but usually the railways do not accept LCL shipments.
WAREHOUSING
The last chapter discussed the management of warehouses. This section is concerned
with the role of warehouses in a physical distribution system.
Warehouses include plant warehouses, regional warehouses, and local warehouses. They may be owned and operated by the supplier or intermediaries such as
wholesalers, or they may be public warehouses. The latter offer a general service to
their public that includes providing storage space and warehouse services. Some
warehouses specialize in the kinds of services they offer and the goods they store.
Physical Distribution
377
A freezer storage is an example. The service functions that warehouses perform can
be classified into two kinds:
1. The general warehouse where goods are stored for long periods and where the
prime purpose is to protect goods until they are needed. There is minimal handling, movement, and relationship to transportation. Furniture storage or a
depository for documents are examples of this type of storage. It is also the type
used for inventories accumulated in anticipation of seasonal sales.
2. The distribution warehouse has a dynamic purpose of movement and mixing.
Goods are received in large-volume uniform lots, stored briefly, and then broken down into small individual orders of different items required by the customer in the marketplace. The emphasis is on movement and handling rather
than on storage. This type of warehouse is widely used in distribution systems.
The size of the warehouse is not so much its physical size as it is the throughput,
or volume of traffic handled.
As discussed in the previous chapter, warehouses, or distribution centers, are
places where raw materials, semi-finished, or finished goods are stored. They represent an interruption in the flow of material and thus add cost to the system. Items
should be warehoused only if there is an offsetting benefit gained from storing them.
Role of Warehouses
Warehouses serve three important roles: transportation consolidation, product mixing, and service.
Transportation consolidation. As shown in the preceding section, transportation costs can be reduced by using warehouses. This is accomplished by consolidating
small (LTL) shipments into large (TL) shipments.
Consolidation can occur in both the supply and distribution systems. In physical
supply, LTL shipments from several suppliers can be consolidated at a warehouse
before being shipped as TL to the factory. In physical distribution, TL shipments can
be made to a distant warehouse and LTL shipments made to local users. Figure 13.5
shows the two situations graphically. Transportation consolidation in physical distribution is sometimes called break-bulk, which means the bulk (TL) shipments from factories to distribution centers are divided into small shipments going to local markets.
Product mixing. Although transportation consolidation is concerned with reduction
of transportation costs, product mixing deals with the grouping of different items into an
order and the economies that warehouses can provide in doing this. When customers
place orders, they often want a mix of products that are produced in different locations.
Without a distribution center, customers would have to order from each source
and pay for LTL transport from each source. Using a distribution center, orders
can be placed and delivered from a central location. Figure 13.6 illustrates the concept.
Chapter 13
PHYSICAL SUPPLY SYSTEM
SUPPLIER A
LTL
Shipments
SUPPLIER B
TL Shipments
(A,B,C)
WAREHOUSE
FACTORY
SUPPLIER C
PHYSICAL DISTRIBUTION SYSTEM
FACTORY A
TL
Shipments
LTL
Shipments
FACTORY B
WAREHOUSE
FACTORY C
M
A
R
K
E
T
Figure 13.5 Transportation consolidation.
MANUFACTURER
A
cts
du C
o
Pr ,B,
A
tA
uc
od
Pr
Product B
od
uc
t
C
MANUFACTURER
B
Pr
378
MANUFACTURER
C
Figure 13.6 Product mixing.
CUSTOMER
Y
DISTRIBUTION
CENTER
Pr
o
A, duct
B, s
C
CUSTOMER
Z
Physical Distribution
379
Service. Distribution centers improve customer service by providing place utility. Goods are positioned close to markets so the markets can be served more
quickly.
Warehousing and Transportation Costs
Any distribution system should try to provide the highest service level (the number of
orders delivered in a specified time) at the lowest possible cost. The particular shipping pattern will depend largely upon the following:
•
•
•
•
Number of customers.
Geographic distribution of the customers.
Customer order size.
Number and location of plants and distribution centers.
Suppliers have little or no control over the first three but do have some control
over the last. They can establish local distribution centers in their markets. With
respect to transportation, it then becomes a question of the cost of serving customers
direct from the central distribution center or from the regional distribution center. If
truckload shipments are made, the cost is less from the central distribution center,
but if LTL shipments are made, it may be cheaper to serve the customer from the
local distribution center.
EXAMPLE PROBLEM
Suppose a company with a plant located in Toronto is serving a market in the northeastern United States with many customers located in Boston. If the company ships
direct to customers from the Toronto plant, most shipments will be less than truckload. However, if it locates a distribution center in Boston, it can ship truckload (TL)
to Boston and distribute by local cartage (LTL) to customers in that area. Whether
this is economical or not depends on the total cost of shipping direct compared with
shipping via the distribution center. Assume the following figures represent the average shipments to the Boston area:
Plant to customer LTL: $100/cwt.
Plant to distribution center TL: $50/cwt.
Inventory-carrying cost (distribution center): $10/cwt.
Distribution center to customer LTL: $20/cwt.
Is it more economical to establish the distribution center in Boston? If the
annual shipped volume is 10,000 cwt., what will be the annual saving?
380
Chapter 13
Answer
Costs if a distribution center is used:
TL Toronto to Boston = $50 per cwt.
Distribution center costs = $10 per cwt.
LTL in Boston area = $20 per cwt.
Total cost = $80 per cwt.
Saving per cwt. = $100 - $80 = $20
Annual saving = $20 * 10,000 = $200,000
Market Boundaries
Continuing with the previous example problem, the company can now supply customers
in other locations directly from the factory in Toronto or through the distribution center
in Boston. The question is to decide which locations should be supplied from each
source. The answer, of course, is the source that can service the location at least cost.
Laid-down cost (LDC) is the delivered cost of a product to a particular geographic
point. The delivered cost includes all costs of moving the goods from A to B. In the previous example problem, the laid-down cost of delivering from Toronto would be the
transportation cost per mile * the miles to a particular destination. The LDC from
Boston would include all costs of getting the goods to Boston, inventory costs in the Boston
distribution center, and the transportation costs in getting to a particular destination.
LDC = P + TX
Where
P = product costs
T = transportation costs per mile
X = distance
The product cost includes all costs in getting the product to the supply location
and storing it there. In the previous example, the product cost at Boston includes the
TL cost of delivery to Boston and the inventory cost at Boston.
EXAMPLE PROBLEM
Syracuse is 300 miles from Toronto. The product cost for an item is $10 per cwt., and
the transportation cost per mile per cwt. is $0.20. What is the laid-down cost per cwt.?
Answer
LDC = Product cost + 1transportation cost per mile21distance2
= $10 + 1$0.20 * 3002 = $70 per cwt.
381
Physical Distribution
Figure 13.7 Market
boundary.
X
Miles
A
100
Miles
(100 − X)
Miles
Y
B
Market boundary. The market boundary is the line between two or more supply
sources where the laid-down cost is the same. Consider Figure 13.7. There are two
sources of supply: A and B. The market boundary occurs at Y where the LDC from
A is the same as B.
In the example shown in Figure 13.7, the distance between A and B is 100
miles. If we let the distance from A to Y be X miles, then the distance from B to Y
is (100 - X ) miles. Assume supply A is the factory and supply B is a distribution
center. Assume the product cost at A is $100 and product cost from B is $100 plus
TL transportation from A to B and inventory costs at B. For this example, assume
the TL transportation and inventory carrying costs are $10 per unit so the product
cost from B is $110. Transportation costs from either A or B are $0.40 per unit
per mile.
Point Y occurs where:
LDCA = LDCB
100 + 0.40X = 110 + 0.401100 - X2
X = 62.5
Thus a point Y, 62.5 miles from A, marks the market boundary between A and B.
EXAMPLE PROBLEM
The distance between Toronto and Boston is about 500 miles. Given the cost structure
in the previous example problems and an LTL transportation cost of $0.20 per cwt.
per mile, calculate the location of the market boundary between Toronto and Boston.
Assume the product cost at Toronto is $10 per cwt.
Answer
The product cost at Boston is the sum of the product cost at Toronto, plus the cost of
TL shipment from Toronto to Boston, plus the handling costs at Boston.
Product cost at Boston = product cost at A + TL transportation + handling costs
= $10 + $50 + $10
= $70
Chapter 13
The market boundary occurs where
LDCT
$10 + $0.20X
0.4X
X
=
=
=
=
LDCB
$70 + $0.201500 - X2
160
400
The market boundary is 400 miles from Toronto or 100 miles from Boston.
Effect on Transportation Costs of Adding More Warehouses
We have seen from the previous example that establishing a distribution center in Boston
reduces total transportation costs. Similarly, if a second distribution center is established,
perhaps in Cleveland, we expect total transportation costs to be reduced further.
Generally, as more distribution centers are added to the system, we can expect
the following:
• The cost of truckload (and carload) shipments to the distribution centers to
increase.
• The cost of LTL shipments to customers to decrease.
• The total cost of transportation to decrease.
As expected, the major savings is from the addition of the first few distribution
centers. Eventually, as more distribution centers are added, the savings decrease. The
first distribution center added to the system is located to serve the largest market; the
second distribution center, the second largest market, and so on. The number of
customers served by additional distribution centers decreases, and the volume that
can be shipped TL to the additional distribution centers is less than to the first distribution centers. Figure 13.8 shows the relationship that exists between transportation
costs and the number of distribution centers in a system.
Figure 13.8 Transportation
cost versus number of
warehouses.
COST IN DOLLARS
382
NUMBER OF WAREHOUSES
Physical Distribution
383
PACKAGING
The basic role of packaging in any industrial organization is to carry the goods safely
through a distribution system to the customer. The package must do the following:
• Identify the product.
• Contain and protect the product.
• Contribute to physical distribution efficiency.
For consumer products, the package may also be an important part of the marketing program.
Physical distribution must not only move and store products but also identify
them. The package serves as a means of identifying the product in a way not possible
from its outward appearance. When shoes are offered in 10 sizes, the package
becomes an important identifier.
Packaging must contain and protect the product, often against a wide range of
hazards such as shock, compression, vibration, moisture, heat, solar radiation, oxidation, and infestation by animals, insects, birds, mold, or bacteria. Packages are subject
to distribution hazards in loading and off-loading, in movement, in transportation,
and in warehousing and storage. The package must be robust enough to protect and
contain the product through all phases of distribution.
Packaging is a pure cost that must be offset by the increased physical distribution efficiency that the package can provide.
There are usually at least three levels of packaging required in a distribution
system. First is a primary package that holds the product—the box of cornflakes.
Next, for small packages, a shipping container such as a corrugated box is needed.
Finally, there is a third level of packaging where several primary or secondary packages are assembled into a unit load.
Unitization
Unitization is the consolidation of several units into large units, called unit loads, so
there is less handling. A unit load is a load made up of a number of items, or bulky
material, arranged or constrained so the mass can be picked up or moved as a single
unit too large for manual handling. Material handling costs decrease as the size of the
unit load increases. It is more economical to move the product by cartons rather than
individually and still more economical to move several cartons in one unit load.
This principle is used when we go shopping and put a number of articles into
bags and then put the bags into the trunk of the car. In industry, unit loads are used
instead of shopping bags.
There are a number of unit-load devices such as sheets, racks, and containers.
One of the most common is the pallet.
As noted in Chapter 12, the pallet is a platform usually measuring
48– * 40– * 4– and designed so that it can be lifted and moved by a forklift industrial
384
Chapter 13
Load A
Load B
Figure 13.9 Stable and unstable pallet loads.
truck. Packages are arranged on it so that several packages may be moved at one time.
Loaded with packages, it forms a cube that is a unit load.
Unitization can be successive. Shippers place their products into primary packages, the packages into shipping cartons, the cartons onto pallets, and the pallets into
warehouses, trucks, or other vehicles.
To use the capacity of pallets, trucks (or other vehicles), and warehouses, there
should be some relationship between the dimensions of the product, the primary
package, the shipping cartons, the pallet, the truck, and the warehouse space. The
packages should be designed so space on the pallet is fully utilized and so the cartons
interlock to form a stable load. Figure 13.9 shows two unit loads each using the total
space of the pallet. However, load B does not interlock and is not stable.
Pallets fit into trucks and railway cars. The standard dimensions were selected
so pallets would fit into nominal 50′ railway cars and 40′ truck trailers with a minimum of lost space. Figure 13.10 shows the layout in railcars and trailers.
Thus to get the highest cube utilization, consideration must be given to the
dimensions of the product, the carton, the pallet, the vehicle, and the warehouse.
MATERIALS HANDLING
Materials handling is the short-distance movement that takes place in or around a
building such as a plant or distribution center. For a distribution center, this means
the unloading and loading of transport vehicles and the dispatch and recall of goods
to and from storage. In addition, the racking systems used in distribution centers are
usually considered to be part of materials handling.
Some objectives of materials handling are as follows:
1. To increase cube utilization by using the height of the building and by reducing
the need for aisle space as much as possible.
385
Physical Distribution
Figure 13.10 Railcar and
trailer pallet position plan.
Nominal 50' Railcar
48"
48"
Nominal 40' Trailer
40"
40"
40 Pallets
Full TL
2 Tiers
56 Pallets
Full CL
2 Tiers
92"
110"
2. To improve operating efficiency by reducing handling. Increasing the load per
move will result in fewer moves.
3. To improve the service level by increasing the speed of response to customer
needs.
There are many types of materials handling equipment. For convenience, they
can be grouped into three categories: conveyors, industrial trucks, and cranes and
hoists.
Conveyors are devices that move material (or people) horizontally or vertically
between two fixed points. They are expensive, create a fixed route, and occupy space
continuously. As a result, they are used only where there is sufficient throughput
between fixed points to justify their cost.
Industrial trucks are vehicles powered by hand, electricity, or propane. Diesel
and gasoline are not used indoors because they are noxious and lethal. Industrial
trucks are more flexible than conveyors in that they can move anywhere there is a
suitable surface and no obstructions. They do not occupy space continuously.
386
Chapter 13
For these reasons, they are the most often-used form of materials handling in distribution centers and in manufacturing.
Cranes and hoists can move materials vertically and horizontally to any point
within their area of operation. They use overhead space and are used to move heavy
or large items. Within their area of operation, they are very flexible.
MULTI-WAREHOUSE SYSTEMS
This section will look at the result of adding more distribution centers to the system.
As might be expected, there is an effect on the cost of warehousing, materials handling, inventories, packaging, and transportation. Our purpose will be to look at how
all of these costs and the total system cost behave. We also want to know what happens to the service level as more distribution centers are added to the system. To
make valid comparisons, we must freeze the sales volume. We can then compare costs
as we add distribution centers to the system.
Transportation Costs
In the section on transportation, we saw that if shipments to customers are in lessthan-full vehicle lots, the total transportation cost is reduced by establishing a distribution center in a market area. This is because more weight can be shipped for
greater distances by truck or carload and the LTL shipments can be made over relatively short distances. Generally, then, as more distribution centers are added to a
system, we expect the following:
• The cost of TL shipments increases.
• The cost of LTL shipments decreases.
• The total cost of transportation decreases.
The major savings are made with the addition of the first distribution centers.
Eventually, as more distribution centers are added, the marginal savings decrease.
Inventory-Carrying Cost
The average inventory carried depends on the order quantity and the safety stock.
The average order quantity inventory in the system should remain the same since it
depends on demand, the cost of ordering, and the cost of carrying inventory.
The total safety stock will be affected by the number of warehouses in the system. Safety stock is carried to protect against fluctuations in demand during the lead
time and depends, in part, on the number of units sold. In Chapter 11, it was shown
that the standard deviation varies as the square root of the ratio of the forecast and
lead-time intervals. Similarly, for the same SKU, the standard deviation varies
approximately as the square root of the ratio of the different annual demands.
387
Physical Distribution
Suppose that the average demand is 1000 units and, for a service level of 90%, the
safety stock is 100 units. If the 1000 units is divided between two distribution centers
each having a demand of 500 units, the safety stock in each is:
SS = 100
500
= 71 units 1in each warehouse2
A 1000
With two distribution centers and the same total sales, the total safety stock
increases to 142 from 100. Thus, with a constant sales volume, as the number of distribution centers increases, the demand on each decreases but there is an increase in
the total safety stock in all distribution centers.
Warehousing Costs
The fixed costs associated with distribution centers are space and materials handling.
The space needed depends on the amount of inventory carried. As we have seen, as
more distribution centers are added to the system, more inventory has to be carried,
which requires more space.
In addition, there will be some duplication of nonstorage space such as washrooms and offices. So as the number of distribution centers increases, there will be a
gradual increase in distribution center space costs.
Operating costs also increase as the number of distribution centers increases.
Operating costs depend largely on the number of units handled. Since there is no
increase in sales, the total number of units handled remains the same, as does the cost
of handling. However, the nondirect supervision and clerical costs increase.
Materials Handling Costs
Materials handling costs depend upon the number of units handled. Since the sales volume remains constant, the number of units handled should also remain constant. There
will be little change in materials handling costs as long as the firm can ship unit loads to
the distribution center. However, if the number of distribution centers increases to the
point that some nonunitized loads are shipped, materials handling costs increase.
Packaging Costs
Per-unit packaging costs will remain the same, but since there will be more inventory,
total packaging costs will rise with inventory.
Total System Cost
We have assumed that total system sales remain the same. Figure 13.11 shows graphically how the costs of transportation, warehousing, materials handling inventory, and
packaging behave as distribution centers are added to the system. Up to a point, total
costs decrease and then start to increase. It is the objective of logistics to determine
this least-cost point.
Chapter 13
Figure 13.11 Total system
cost.
Transp.
Total Cost
Inventory
Packaging
Warehouse
Materials
Handling
COST IN DOLLARS
388
NUMBER OF WAREHOUSES
Figure 13.12 Estimate of
market reached versus number
of warehouses.
Number of
Warehouses
1
2
3
10
Percentage of Market
Reached in 1 Day
30
70
87
95
System Service Capability
The service capability of the system must also be evaluated. One way of assessing this
is by estimating the percentage of the market served within a given period. Figure
13.12 represents such an estimate.
As expected, the service level increases as the number of distribution centers
increases. It increases rapidly from one to two distribution centers and much less
rapidly as the number is further increased. The first distribution center is built to
serve the best market, the next to serve the second best market, and so on. Let us
assume that a study has been made of a system of 1 to 10 distribution centers and the
costs are as shown in Figure 13.13.
A three-distribution center system would provide the least total cost. Figure 13.13
shows that by moving from 3 to 10 distribution centers, the 1-day service level
increases by 8%. Management must decide which system to select. The decision must
be based on adequate analysis of the choices available and a comparison of the
increase in costs and service level.
389
Physical Distribution
Cost ($1000)
Transportation
Warehousing
Materials Handling
Inventory
Packaging
Total Cost
1
$8000
500
1000
400
100
$10,000
Number of Locations
2
3
$6000
$5000
600
700
1000
1100
425
460
100
100
$8125
$7360
10
$4500
900
1400
700
100
$7600
Figure 13.13 Cost versus number of warehouses.
KEY TERMS
Physical supply 360
Physical distribution 360
Transaction channel 361
Distribution channel 361
Transportation 365
Distribution inventory 365
Warehouses (distribution
centers) 365
Materials handling 365
Protective packaging 365
Order processing and
communication 365
Cost trade-off 366
Total cost 366
Fixed costs 369
Variable costs 369
Ways 369
Terminals 369
Vehicles 369
Common carriers 371
Contract carriers 372
Private carriers 372
Total line-haul cost 373
Line-haul cost per hundred
weight 373
Pickup and delivery costs
375
Terminal-handling costs 375
Billing and collecting costs
375
Value 376
Density 376
Perishability 376
Packaging 376
General warehouse 377
Distribution warehouse 377
Break-bulk 377
Laid-down cost (LDC) 380
Market boundary 381
Unitization 383
Unit loads 383
Pallet 383
Conveyors 385
Industrial trucks 385
Cranes and hoists 386
QUESTIONS
1. Name and describe the three functions in the flow of materials from supplier to consumer. What are the differences between physical supply and physical distribution?
2. What is the primary function of the transaction channel and the distribution channels?
3. The particular way that goods move depends in part on four factors. What are they?
4. Describe the reverse logistics system of a beverage company including the movement of
goods and the flow of payment. What steps does the company take to reduce their costs?
5. Why are the total costs associated with reverse logistics increasing? Will this trend
continue into the future?
6. What are the objectives of a physical distribution system?
7. Name and describe each of the six system activities in a physical distribution system.
390
Chapter 13
8. What are the cost trade-off and total cost concepts? Why are they important?
9. Describe the relationship between marketing and physical distribution. How does physical distribution contribute to creating demand?
10. Why is the demand placed on a central distribution center or a factory by distribution
centers considered dependent?
11. What are the five basic modes of transportation?
12. What are the three physical elements in a transportation system? For each of the five
modes, describe who provides them and how they are funded.
13. Describe why train service is cheaper than road transport for large quantities of bulky
commodities moving over long distances.
14. Why can trucks provide a fast, flexible service for the distribution of small volumes of
goods to a dispersed market?
15. What are the major characteristics of water and air transport?
16. What are the major legal types of carriage? What are the three areas of economic regulation? To which legal type of carriage do they apply?
17. Compare common and contract carriage. How do they differ from private carriage?
Which will give the highest level of service?
18. On what do total line-haul costs and line-haul costs per hundredweight depend? What
two ways can shippers reduce line-haul costs?
19. Describe how a shipper can reduce the following:
a. Pickup and delivery costs.
b. Terminal-handling costs.
c. Billing and collecting costs.
20. The rates charged by a shipper vary with the commodity shipped. Name and describe
four factors that affect the rates.
21. Why are LTL rates more expensive than TL rates?
22. Name and describe the two basic types of warehouses.
23. Name and describe the three important roles warehouses serve.
24. Name four factors that affect shipping patterns. Which can a supplier control?
25. What is the laid-down cost? What is a market boundary? Why are laid-down costs
important in determining market boundaries?
26. As more distribution centers are added to a system, what happens to the cost of truckload, less than truckload, and total transportation costs?
27. What are the three roles of packaging in a distribution system? Describe why each is
important.
28. What is unitization? Why is it important in physical distribution? Why is it successive?
29. What are three prime objectives of materials handling? Describe the characteristics of
conveyors, industrial trucks, cranes, and hoists.
30. As more warehouses are added to the system, what would we expect to happen to the
following:
a. Transportation costs.
b. Inventory costs.
391
Physical Distribution
c. Materials handling costs.
d. Packaging costs.
e. Total system costs.
f. System service capability.
PROBLEMS
13.1 A company normally ships to a customer by rail at a cost of $500 per load. The transit
time is 14 days. The goods can be shipped by truck for $700 per load and a transit time of
four days. If transit inventory cost is $35 per day, what does it cost to ship each way?
Answer.
Rail, $990; truck, $840
13.2 A company manufactures component parts for machine tools in North America and
ships them to Southeast Asia for assembly and sale in the local market. The components
are shipped by sea, transit time averages six weeks, and the shipping costs $1000 per
shipment. The company is considering moving the parts by air at an estimated cost of
$7500; the shipment taking two days to get there. If inventory in transit for the shipment
costs $150 per day, should they ship by air?
In Chapter 8, it was said that forecasts are more accurate for nearer periods of time.
Should this be considered? What activities are affected by the shorter lead time?
13.3 For a given commodity, the line-haul cost is $13 per mile. For a trip of 200 miles and a
shipment of 300 cwt., what is the cost per hundredweight? If the shipment is increased to
500 cwt., what is the saving in cost per hundredweight?
Answer.
$3.47 per cwt.
13.4 A company ships a particular product to a market located 1000 miles from the plant at a
cost of $4 per mile. Normally it ships 500 units at a time. What is the line-haul cost per
unit?
13.5 In problem 13.4, if the company can ship the units unassembled, it can ship 800 units in
a truck. What is the line-haul cost per unit now?
Answer.
Line-haul cost per unit = $5
13.6 A company processes feathers and ships them loose in a covered truck. The line-haul
cost for an average shipment is $250, and the truck carries 2000 pounds of feathers.
A bright new graduate has just been hired and has suggested that they should bale the
feathers into 500-pound bales. This would make them easier to handle and also allow
them to be compressed into about one-tenth of the space they now occupy. How many
pounds of feathers can the truck now carry? What is the present line-haul cost per
pound? What will it be if the proposal is adopted?
13.7 A company in Calgary serves a market in the northwestern United States. Now it ships
LTL at an average cost of $28 per unit. If the company establishes a distribution center
in the market, it estimates the TL cost will be $15 per unit, inventory-carrying costs will
be $6 per unit, and the local LTL cost will average $6 per unit. If the company forecasts
annual demand at 100,000 units, how much will they save annually?
Answer.
Annual saving = $100,000
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Chapter 13
13.8 A company ships LTL to customers in a market in the Midwest at an average cost of $40
per cwt. It proposes establishing a distribution center in this market. If TL shipment
costs $20 per cwt., the estimated inventory-carrying costs are $5 per cwt., and the local
cartage (LTL) cost is estimated at $6 per cwt. If the annual shipped volume is 100,000
cwt., what will the annual savings be by establishing the distribution center?
13.9 A company has a central supply facility and a distribution center located 500 miles away.
The central supply product cost is $20, TL transportation rates from central supply to the
DC are $50 per unit, and inventory-carrying costs are $4 per unit. Calculate the market
boundary location and the laid-down cost at the market boundary. LTL rates are $1 per
unit per mile.
Answer.
Market boundary is 277 miles from central supply. LDC = $297.
13.10 Suppose the company in problem 13.8 had another market area located between the
parent plant and the proposed distribution center. The LTL costs from the plant to that
market are $35 per cwt. The company estimates that LTL shipments from the distribution center will cost $4 per cwt. Should it supply this market from the distribution center
or central supply?
13.11 A company can ship LTL direct to customers in city A or use a public warehouse located
in city B. It has determined the following data.
Cost per cwt. for shipping LTL to city A is $0.70 + $0.30 per mile.
Cost per cwt. for shipping TL to warehouse is $0.40 + $0.15 per mile.
Warehouse handling costs are $0.30 per cwt.
Distances: Plant to city A = 115 miles
Plant to city B = 135 miles
From city B to city A = 30 miles
a. What is the total cost per cwt. to ship from the plant direct to customers in city A?
b. What is the total cost per cwt. to ship via the warehouse in city B?
c. In this problem, the cost per cwt. has a fixed and a variable component. Why?
Physical Distribution
393
METAL SPECIALTIES, INC.
Metal Specialties is a wholesaler of specialty metals such as stainless steels and tool
steels. The company purchases its stainless steel from a mill located some 200 miles
away. At present the company operates its own truck. However, the truck is in need
of repair, and this is estimated to be about $20,000. Annual operating costs are
$30,000 and the line-haul costs are $2.20 per mile. Janet Jones (JJ), the traffic manager, wants to reduce the cost of bringing in the stainless steel, and because of the
impending repairs, she feels now is a good time to look at alternatives. She has
solicited a number of proposals and has narrowed her choices down to a motor carrier and a rail carrier.
Heavy Metal Transport (HMT), a contract motor carrier, has an excellent reputation for service and reliability. It has submitted an incremental rate, $4.00/cwt., for
shipments weighting less than 150 cwt., $3.80 for shipments between 150 and 200
cwt., $3.60 for shipments between 200 and 250 cwt., and $3.40 for shipments over
250 cwt. up to a maximum of 400 cwt.
Midland Continental Railway has submitted a piggyback rate of $3.25 per cwt.
with a minimum load of 200 cwt. The piggyback rate includes pickup by truck at the
steel mill, line haul by trailer on flat car, and delivery by truck to Metal Specialities’
warehouse. They are considered to be a reliable carrier as well.
The finance department estimates that Metal Specialities’ annual inventory carrying cost is 20%, the cost of inventory in transit is 10%, and the cost of capital is 8%.
The cost of placing an order for stainless steel is estimated to be $40 per order.
Stainless steel presently costs $300 per cwt.
Case Analysis
1. JJ has to make a decision soon. Given the information provided, what would you
advise her to do?
14
Products and Processes
INTRODUCTION
The effect and the efficiency of operations management, just-in-time manufacturing,
and total quality management all depend on the way products are designed and the
processes selected. The way products are designed determines the processes that are
available to make them. The product design and the process determine the quality
and cost of the product. Quality and cost determine the profitability of the company.
This chapter studies the relationship between product design and process design and
the costs associated with different types of processes. Finally, the chapter looks at the
improvement of existing processes.
NEED FOR NEW PRODUCTS
Products, like people, have a limited life span. A product passes through several
stages, known as the product life cycle, beginning with its introduction and ending
with its disappearance from the marketplace. Figure 14.1 gives a simplified view of
the profit and volume relationships in each phase of the cycle. No time scale is
implied. The life cycle may take months or years to complete depending on the products and the market.
394
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Products and Processes
Figure 14.1 Life cycle
of a product
INTRODUCTION
GROWTH
MATURITY
DECLINE
SALES
PROFIT
0
TIME
Introduction phase. This phase is the most expensive and risky stage. To get customer acceptance of the product the firm will usually spend heavily on advertising
and sales promotion, hoping these costs will be recovered in future sales. If the introduction fails the firm loses money, a fact that underlines the importance of thoroughly researching a new product before introducing it.
Growth phase. In this phase, sales of a successful product increase at a rapid rate.
Production increases and the unit cost of the product drops. The increased sales volume and the lower unit cost cause profits to increase rapidly. However, the success of
the product usually attracts the attention of competitors. Their entrance into the
market forces prices down, possibly reducing the firm’s sales. At this point profits are
squeezed.
Maturity or saturation phase. Nearly everyone interested in the product has
sampled or owns the product and sales begin to level off. The market is saturated.
Price competition is often severe and profits start to decline.
Decline phase. Sales drop as customers begin to lose interest in the product or to
buy improved versions from competitors. As profits decline still further, companies
will look for ways to maintain profitability. Generally, there are three ways in which
this can be done:
• Introduce new products.
• Improve existing products.
• Improve the methods of production.
Depending on the firm’s resources it may do these things through its own
research and development, by copying competitors’ products, or by relying on customers or suppliers to do the research and development work. We will concern ourselves with the firm that does its own research, development, and engineering.
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PRODUCT DEVELOPMENT PRINCIPLES
A few organizations supply a single product, but most supply a range of similar or
related products. There are two conflicting factors to be considered in establishing
the range of products to supply.
• If the product line is too narrow, customers may be lost.
• If the product line is too wide, customers may be satisfied, but operating costs
will increase because of the lack of specialization.
Sales organizations are responsible for increasing sales and revenue. They want
to offer product variety to consumers. Often this means the organization must offer a
variety of products, many of which sell in small volumes.
Operations, on the other hand, would like to produce as few products as possible and make them in long runs. In this way it could reduce the number of setups (and
cost) and probably lower run costs by using special machinery. It would fulfill its mandate to produce at the lowest cost.
Somehow the needs of sales and the economics of production must be balanced. Usually this balance can be obtained with good programs of:
• Product simplification.
• Product standardization.
• Product specialization.
Simplification
Simplification is the process of making something easier to do or make. It seeks to
cut out waste by getting rid of needless product varieties, sizes, and types. The
emphasis is not in cutting out products simply to reduce variety but to remove unnecessary products and variations.
As well as reducing the variety of parts, product design can often be simplified
to reduce operations and material costs. For example, the use of a snap-on plastic cap
instead of a screw cap reduces the cost of both materials and labor.
Standardization
In product design, a standard is a carefully established specification covering the
product’s material, configuration, measurements, and so on. Thus, all products made
to a given specification will be alike and interchangeable. Light bulbs are a good
example of standardization: the sockets and wattage are standardized and the light
bulbs are interchangeable.
A range of standard specifications can be established so it covers most uses for
the item. Men’s shirts are made in a range of standard collar sizes and sleeve lengths so
nearly everyone can be fitted. Most shirt manufacturers also use the same standards so
the consumer can get the same size shirt from any manufacturer and expect it to fit.
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397
Because product standardization allows parts to be interchangeable, as long as
the range of standard specifications has been well-chosen, a smaller variety of components is needed. Using the example of light bulbs, the wattages are standardized at
40, 60, and 100 watts. This range allows users to pick wattages that satisfy their needs
and manufacturers to reduce the number of different bulbs, thus reducing inventory.
Another aspect of standardization is the way parts fit together. If the designs of
assemblies are standardized so various models or products are assembled in the same
way, then mass production is possible. The automotive industry designs automobiles
so many different models can be assembled on the same assembly line. For example,
several different engines can be mounted in a chassis because the engines are mounted
in the same way and designed so they will all fit into the engine compartment.
Modularization. Modularization uses standarized parts for flexibility and variety.
Standardization does not necessarily reduce the range of choice for the customer. By
standardizing on component parts, a manufacturer can make a variety of finished goods,
one of which will probably satisfy the customer. Automobile manufacturing is a prime
example of this. Cars are usually made from a few standard components and a series of
standard options so the consumer has a selection from which to choose. For example,
the Mazda Miata contains 80% standard parts, which enables Mazda to produce the
car quickly and at low cost, thus making a profit even though sales are comparatively
small. Chrysler uses one platform—the basic frame of the vehicle—for all models of its
minivan. Thus the company has only one set of frame costs for all minivans.
Specialization
Specialization is concentration of effort in a particular area or occupation.
Electricians, doctors, and lawyers specialize in their chosen fields. In product specialization, a firm may produce and market only one or a limited range of similar products. This leads to process and labor specialization, which increases productivity and
decreases costs.
With a limited range of products, productivity can be increased and costs
reduced by:
• Allowing the development of machinery and equipment specially designed to
make the limited range of products quickly and cheaply.
• Reducing the number of setups because of fewer task changes.
• Allowing labor to develop speed and dexterity because of fewer task changes.
Specialization is sometimes called focus and can be based either on product and market or on process.
Product and market focus. Product and market focus can be based on characteristics such as customer grouping (serving similar customers), demand characteristics (volume), or degree of customization. For example, one company may specialize
in a limited range of high-volume products, whereas another may specialize in providing a wider range of low-volume products with a high level of customization.
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Process focus. Process focus is based on the similarity of process. For example,
automobile manufacturers specialize in assembling automobiles. Other factories and
companies supply the assemblers with components and the assembler specializes in
assembly operations.
Focused factory. Currently there is a trend toward more specialization in manufacturing whereby a factory specializes in a narrow product mix for a niche market.
Generally focused factories are thought to produce more effectively and economically than more complex factories, the reason being that repetition and concentration
in one area allow the workforce and management to gain the advantages of specialization. The focused factory may be a “factory within a factory,” an area in an existing
factory set aside to specialize in a narrow product mix.
Specialization has the disadvantage of inflexibility. Often it is difficult to use
highly specialized labor and equipment for tasks other than those for which they were
trained or built.
In summary, the three ideas of simplification, standardization, and specialization are different but interrelated. Simplification is the elimination of the superfluous
and is the first step toward standardization. Standardization is establishing a range of
standards that will meet most needs. Finally, specialization would not be possible
without standardization. Specialization is concentration in a particular area and
therefore implies repetition, which cannot be arrived at without standard products or
procedures.
A program of product simplification, standardization, and specialization allows
a firm to concentrate on the things it does best, provides the customers with what they
want, and allows operations to perform with a high level of productivity. Reducing
part variety will create savings in raw material, work-in-process, and finished goods
inventory. It will also allow longer production runs, improve quality because there are
fewer parts, and improve opportunities for automation and mechanization. Such a
program contributes significantly to reducing cost.
PRODUCT SPECIFICATION AND DESIGN
Product design is responsible for producing a set of specifications that manufacturing
can use to make the product. Products must be designed to be:
• Functional.
• Capable of low-cost processing.
Functional. The product will be designed to perform as specified in the marketplace. The marketing department produces a market specification laying down the
expected performance, sales volume, selling price, and appearance values of the product. Product design engineers design the product to meet the market specifications.
Products and Processes
399
Engineers establish the dimensions, configurations, and specifications so the item, if
properly manufactured, will perform as expected in the marketplace.
Low-cost processing. The product must be designed so it can be made at least
cost. The product designer specifies materials, tolerances, basic shapes, methods of
joining parts, and so on and, through these specifications, sets the minimum product
cost. Usually, many different designs will satisfy functional and appearance specifications. The job then is to pick the design that will minimize manufacturing cost.
Poor design can add cost to processing in several ways:
• The product and its components may not be designed to be made using the
most economical methods impossible.
• Parts may be designed so excessive material has to be removed.
• Parts may be designed so operations are difficult.
• Lack of standardized components may mean batches of work have to be small.
Using standard parts across a range of products reduces the number of parts in
inventory, tooling, and operator training and permits the use of special-purpose
machinery. All this reduces product cost.
• Finally, product design can influence indirect costs such as production planning, purchasing, inventory management, and inspection. For example, one
design may call for 20 different nonstandard parts, whereas another uses 15
standard parts. The effort required to plan and control the flow of materials and
the operations will be greater, and more costly, in the first case than the second.
Low cost has to be designed into the product.
Simultaneous Engineering
To design products for low-cost manufacture requires close coordination between
product design and process design, which is called simultaneous engineering. If the
two groups can work together, they have a better chance of designing a product that
will function well in the marketplace and can be manufactured at least cost. This relationship between product design and process design can spell the success or failure of
a product. If a product cannot be produced at a cost that will allow a profit to be
made, then it is a failure for the firm.
The traditional approach to product and process design has been a little like a
relay race. When product design finished, it would pass the work to process design
and let that department figure out how to make it. This system has proved time
consuming and expensive. Figure 14.2 shows, with some humor, what can happen
without strong communication and interaction between all parties in the product
development cycle.
Today, many organizations concurrently develop the design for the product and
the process. Often a team is made up of people from product design, process design,
quality assurance, production planning and inventory control, purchasing, marketing,
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Figure 14.2 Communication
is essential.
HERE'S WHAT THE
MARKETING FOLKS
REQUESTED
HERE'S WHAT
THE R AND D
BOYS TESTED
HERE'S WHAT THE
CAD CODE DREW
REAL FAST
TENSILE
STRENGTH
2'
HERE'S WHAT WAS
MANUFACTURED IN
MASS
HERE'S WHAT
SALES INSTALLED,
UNDAUNTED
HERE'S WHAT THE
CUSTOMER
REALLY WANTED
field service, and others who contribute to, or are affected by, the delivery of the
product to the customer. This group works together to develop the product design so
it meets the needs of the customer and can be made and delivered to the customer at
low cost in a process called concurrent engineering.
There are several advantages to this approach:
• Time to market is reduced. The organization that gets its products to market
before the competition gains a strong competitive advantage.
• Cost is reduced. Involving all stakeholders early in the process means less need
for costly design changes later.
• Better quality. Because the product is designed for ease of manufacture and
ease of maintaining quality in manufacture, the number of rejects will be
reduced. Because quality is improved, the need for after-sales service is
reduced.
• Lower total system cost. Because all groups affected by the product design are
consulted, all concerns are addressed. For example, field service might need a
product that is designed so it is easy to service in the field, thus reducing servicing costs.
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Products and Processes
PROCESS DESIGN
Operations management is responsible for producing the products and services the customer wants, when wanted, with the required quality, at minimum cost and maximum
effectiveness and productivity. Processes are the means by which operations management reaches these objectives.
A process is a method of doing something, generally involving a number of steps or
operations. Process design is the developing and designing of the steps.
Everything we do involves a process of some description. When we go to the
bank to deposit or withdraw money, prepare a meal, or go on a trip we are involved in
a process. Sometimes, as consumers, we are personally involved in the process. Most
of us have waited at a checkout counter in a store and wondered why management
has not devised a better process for serving customers.
Nesting. Another way of looking at the hierarchy of processes is the concept of
nesting. Small processes are linked to form a larger process. Consider Figure 14.3.
Level zero shows a series of steps, each of which may have its own series of steps. One
of the operations on level zero is expanded into its component parts and shown on
level one. The nesting can continue to further levels of detail.
Mass customization. Recent changes in process flexibility have allowed for the
development of a concept called mass customization. If the operation is designed to
be flexible and efficient enough, it will allow the production of customized products
(specific to customer demand) at virtually the same cost as mass-produced product.
LEVEL ZERO
LEVEL ONE
Figure 14.3 Nesting concept.
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FACTORS INFLUENCING PROCESS DESIGN
Five basic factors must be considered when designing a process.
Product design and quality level. The product’s design determines the basic
processes needed to convert the raw materials and components into the finished
product. For example, if a steak is to be barbecued, then the process must include a
barbecue operation. The process designer can usually select from a variety of different machines or operations to do the job. The type of machine or operation selected
will depend upon the quantity to be produced, the available equipment, and the quality level needed.
The desired quality level affects the process design, because the process must be
capable of achieving that quality level and doing it repeatedly. If the process cannot
do that, operations will not be able to produce what is wanted except with expensive
inspection and rework. The process designer must be aware of the capabilities of
machines and processes and select those that will meet the quality level at least cost.
Demand patterns and flexibility needed. If there is variation in demand for a
product, the process must be flexible enough to respond to these changes quickly. For
example, if a full-service restaurant sells a variety of foods, the process must be flexible enough to switch from broiling hamburgers to making pizzas. Conversely, if a
pizza parlor sells nothing but pizzas, the process need not be designed to cook any
other type of food. Flexible processes require flexible equipment and personnel capable of doing a number of different jobs.
Quantity/capacity considerations. Product design, the quantity to produce,
and process design are closely related. Both product and process design depend on
the quantity needed. For example, if only one of an item is to be made, the design and
the process used will be different than if the volume is 100,000 units. The quantity
needed and the process design determine the capacity needed. Figure 14.4 shows this
relationship. Note that all three are directly connected to the customer.
Customer involvement. Chapter 1 discussed four manufacturing strategies—
engineer-to-order, make-to-order, assemble-to-order, and make-to-stock—and the
extent of customer involvement in each. Process design will depend on which strategy
is chosen.
Make or buy decision. A manufacturer has the alternative of making parts inhouse or of buying them from an outside supplier. Few companies make everything
or buy everything they need. Indeed, on the average, North American manufacturers
purchase more than 50% of the cost of goods manufactured. A decision has to be
made about which items to make and which to buy. Although cost is the main determinant, other factors such as the following are usually considered:
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Products and Processes
Figure 14.4 Product design,
process design, and capacity
are closely related.
What to
produce?
PRODUCT
DESIGN
CUSTOMER
PROCESS
DESIGN
How to
produce?
CAPACITY
How much
to produce?
•
•
•
•
•
Reasons to Make In-House
Can produce for less cost than a supplier.
To utilize existing equipment to fullest extent.
To keep confidential processes within control of the firm.
To maintain quality.
To maintain workforce.
•
•
•
•
Reasons to Buy Out
Requires less capital investment.
Uses specialized expertise of suppliers.
Allows the firm to concentrate on its own area of specialization.
Provides known and competitive prices.
The decision to make or buy is clear for many items such as nuts and bolts,
motors, or components that the firm does not normally manufacture. For other items
that are in the firm’s specialty area, a specific decision will have to be made.
As supply chains are becoming more tightly linked and sources of supply are
becoming more global, the issue to buy (outsource) becomes more complex. For
example, exchange rates, transit inventory levels, impact of transit time on lead time,
and government controls are all becoming issues that need to be considered in making the decision to make or buy.
PROCESSING EQUIPMENT
Processing equipment can be classified in several ways, but for our purposes one of
the most convenient is the degree of specialization of machinery and equipment.
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General-purpose machinery. General-purpose machinery can be used for a
variety of operations or can do work on a variety of products within its machine classification. For example, a home sewing machine can sew a variety of materials,
stitches, and patterns within its basic capability. Different auxiliary tools can be used
to create other stitches or for particular sewing operations.
Special-purpose machinery. Special-purpose machinery is designed to perform
specific operations on one work piece or a small number of similar work pieces. For
example, a sewing machine built or equipped to sew shirt collars would be a specialpurpose machine capable of sewing collars on any size shirt of any color but not capable of performing other sewing operations unless it was modified extensively.
General-purpose machinery is generally less costly than special-purpose machinery. However, its runtime is slow, and because it is operated by humans, the quality
level tends to be lower than when using special-purpose machinery. One exception is
Robotic machines, which automate the human aspect and tend to produce high quality,
but the cost is much higher. Special-purpose machinery is less flexible but parts can be
produced with it much quicker than with general-purpose machinery.
PROCESS SYSTEMS
Depending on the product design, volume, and available equipment, the process
engineer must design the system to make the product. Based on material flow,
processes can be organized in three ways:
• Flow.
• Intermittent.
• Project (fixed position).
The system used will depend on the demand for the item, range of products,
and the ease or difficulty of moving material. All three systems can be used to make
discrete units such as automobiles or textbooks, or to make nondiscrete products
such as gasoline, paint, or fertilizer.
Flow Processes
Workstations needed to make the product, or family of similar products, are grouped
together in one department and are laid out in the sequence needed to make the
product. Examples are assembly lines, cafeterias, oil refineries, and steel rolling mills.
In flow processing, work flows from one workstation to another at a nearly constant
rate and with no delays. There is some form of mechanical method of moving goods
between workstations. If the units are discrete, such as automobiles, flow manufacturing is called repetitive manufacturing. If not, for example gasoline, it is called
continuous manufacturing. The typical flow pattern is shown in Figure 14.5. Flow
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Products and Processes
WORKSTATIONS
Output
Input
1
2
3
4
Figure 14.5 Material flow: flow process.
process layout is sometimes called product layout because the system is set up for a
limited range of similar products.
Flow systems produce only a limited range of similar products. For example, an
assembly line produces a certain type of refrigerator and cannot be used to assemble
washing machines. The operations used to make one are different and in a different
sequence than those used for making the other. Demand for the family of products
has to be large enough to justify setting up the line economically. If sufficient demand
exists, flow systems are extremely efficient for several reasons:
• Workstations are designed to produce a limited range of similar products, so
machinery and tooling can be specialized.
• Because material flows from one workstation to the next, there is very little
buildup of work-in-process inventory.
• Because of the flow system and the low work-in-process inventory, lead times
are short.
• In most cases, flow systems substitute capital for labor and standardize what
labor there is into routine tasks.
Because it is so cost effective, this system of processing should be used wherever
and to whatever extent it can be.
Intermittent Processes
In intermittent manufacturing, goods are not made continuously as in a flow system
but are made at intervals in lots or batches. Workstations must be capable of processing many different parts. Thus it is necessary to use general-purpose workstations and
machinery that can perform a variety of tasks.
General-purpose workstations do not produce goods as quickly as specialpurpose workstations used in flow manufacturing. Usually, workstations are organized
into departments based on similar types of skills or equipment. For example, all welding and fabrication operations are located in one department, machine tools in
another, and assembly in yet another department. Work moves only to those workstations needed to make the product and skips the rest. This results in the jumbled
flow pattern shown in Figure 14.6.
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WORKSTATIONS
Product A
1
2
3
4
5
6
7
8
9
Product B
Product C
Figure 14.6 Material flow: intermittent process.
Intermittent processes are flexible. They can change from one part or task to
another more quickly than can flow processes. This is because they use general-purpose
machinery and skilled flexible labor that can perform the variety of operations needed.
Control of work flow is managed through individual work orders for each lot or
batch being made. Because of this and the jumbled pattern of work flow, manufacturing planning and control problems are severe. Often, many work orders exist, each
of which can be processed in different ways.
Provided the volume of work exists to justify it, flow manufacturing is less costly
than intermittent manufacturing. There are several reasons for this:
• Setup costs are low. Once the line is established, changeovers are needed infrequently to run another product.
• Since work centers are designed for specific products, run costs are low.
• Because products move continuously from one workstation to the next, workin-process inventory will be low.
• Costs associated with controlling production are low because work flows
through the process in a fixed sequence.
But the volume of specific parts must be enough to use the capacity of the line
and justify the capital cost.
Project (Fixed Position) Processes
Project, or fixed position, manufacturing is mostly used for large, complex projects
such as locomotives, ships, or buildings. The product may remain in one location for
its full assembly period, as with a ship, or it may move from location to location after
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Products and Processes
considerable work and time are spent on it. Large aircraft are made this way. Project
manufacturing has little advantage except it avoids the very high costs of moving the
product from one workstation to another.
There are many variations and combinations of these three basic types of
processes. Companies will try to find the best combination to make their particular
products. In any one company it is not unusual to see examples of all three being used.
SELECTING THE PROCESS
Generally, the larger the volume (quantity) to be produced, the greater the opportunity to use special-purpose processes. The more special purpose an operation, the
faster it will produce. Often the capital cost for such machinery or for special tools or
fixtures is high. Capital costs are called fixed costs and the production, or run, costs
are called variable costs.
Fixed costs. Costs that do not vary with the volume being produced. Purchase
costs of machinery and tools and setup costs are considered fixed costs. No matter
what volume is produced, these costs remain the same. If it costs $200 to set up a
process, this cost will not change no matter how much is produced.
Variable costs. Costs that vary with the quantity produced. Direct labor (labor
used directly in the making of the product) and direct material (material used directly
in the product) are the major variable costs. If the runtime for a product is 12 minutes
per unit, the labor cost $10 per hour, and the material cost $5 per unit, then:
Variable cost =
12
* $10.00 + $5.00 = $7.00 per unit
60
Let:
FC Fixed cost
VC Variable cost per unit
x Number of units to be produced
TC Total cost
UC Unit (average) cost per unit
Total cost Fixed cost (Variable cost per unit)(number of units produced)
Then:
TC = FC + VC x
Total cost
TC
Unit cost =
=
x
number of units produced
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EXAMPLE
A process designer has a choice of two methods for making an item. Method A has a
fixed cost of $2000 for tooling and jigs and a variable cost of $3 per unit. Method B
requires a special machine costing $20,000 and the variable costs are $1 per piece. Let
x be the number of units produced.
Method A
$2000.00
$3.00
$2000.00 + 3x
$2000.00 + 3x
x
Fixed cost
Variable unit cost
Total cost
Unit (average) cost
Method B
$20,000.00
$1.00
$20,000.00 + 1x
$2000.00 + 1x
x
Table 14.1 shows what happens to the total cost as quantities produced are
increased. The total cost data in this table are shown graphically in Figure 14.7. From
Table 14.1 and Figure 14.7, we can see that initially the total cost and unit cost of
method A are less than method B. This is because the fixed cost for method B is
greater and has to be absorbed over a small number of units. Although the total cost
for both methods increases as more units are produced, the total cost for method A
increases faster until, at some quantity between 8000 and 10,000 units, the total cost
for method B becomes less than for method A.
Volume
Total Cost (Dollars)
Unit Cost (Dollars)
(Units)
Method A
Method B
Method A
2000
$8000
$22,000
$4.00
$11.00
4000
14000
24000
3.5
6
6000
20000
26000
3.33
4.33
8000
26000
28000
3.25
3.5
10000
32000
30000
3.2
3
12000
38000
32000
3.17
2.67
14000
44000
34000
3.14
2.43
16000
50000
36000
3.13
2.25
Table 14.1 Total and average cost versus quantity produced.
Method B
409
Products and Processes
50
LEGEND
METHOD A
METHOD B
COST ($1000)
40
30
20
COST
EQUALIZATION
POINT
10
0
0
2
4
6
8
10
12
14
16
VOLUME (1000 UNITS)
Figure 14.7 Total cost versus quantity produced.
Similarly, the unit cost for both methods decreases as more units are produced.
However, the unit cost for method B decreases at a faster rate until, at some quantity
between 8000 and 10,000 units, they are equal.
Cost Equalization Point (CEP)
Knowing the quantity beyond which the cost of using method B becomes less than for
method A enables us to decide easily which process to use to minimize the total cost
(and the unit cost).
This quantity is called the cost equalization point (CEP) and is the volume for
which the total cost (and unit cost) of using one method is the same as another. For
our example, the total cost calculations are as follows.
TCA
FCA + VCAx
$2000 + $3x
3x - 1 x
2x
x
=
=
=
=
=
=
TCB
FCB + VCB x
$20,000 + $1x
20,000 - 2000
18,000
9000 units
The CEP is 9000 units. At this quantity the total cost of using method A will be
the same as for method B.
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Chapter 14
TCA = FCA + VCAx - 2000 + 13 * 90002 = $29,000
TCB = FCB + VCB x = 20,000 + 11 * 90002 = $29,000
We can get the same results by using unit costs instead of total costs.
From the preceding calculations we can say:
• If the volume (quantity to produce) is less than the CEP, the method with the
lower fixed cost will cost less.
• If the volume is greater than the CEP, the method with the greater fixed cost
will cost less.
For example, if the volume were 5000 units, method A would cost less, and if
the volume were 10,000 units, method B would cost less.
Variable costs, mostly direct labor and material, can be reduced by substituting
machinery and equipment (capital) for direct labor. This increases the fixed costs and
decreases the variable costs. But to justify this economically the volume must be high
enough to reduce the total or unit cost of production.
Increasing Volume
The obvious way to increase volume is to increase sales. However, a finished product
is made up of several purchased or manufactured components. If the volume of these
components can be increased, then the unit cost of the components, and the final
product, will be reduced.
The volume of components can be increased without increasing sales by a program of simplification and standardization, discussed previously in this chapter.
If a subassembly or component part can be standardized for use in more than
one final product, then the volume of the subassembly or part is increased without an
increase in the total sales volume. Thus more specialized and faster-running
processes can be justified and the cost of operations reduced.
Standardization of parts is a major characteristic of modern mass production.
At the turn of the century, Henry Ford revolutionized manufacturing by standardizing the finished product—one model of car. The joke often heard then was that you
could have any color you wanted as long as it was black. Today a vast range of models
are made, but if each model was exploded into its subassemblies and component
parts, we would find specific components common to a great number of models. In
this way, modern manufacturers can provide the consumer with a wide choice of finished products made from standard parts and components.
CONTINUOUS PROCESS IMPROVEMENT (CPI)
People have always been concerned with how best to do a job and the time it should
take to do it. Process improvement is concerned with improving the effective use of
human and other resources. Continuous implies an ongoing activity; improvement
Products and Processes
411
implies an increase in the productivity or value of quality or condition. Hence the
name Continuous Process Improvement.
Continuous process improvement consists of a logical set of steps and techniques used to analyze processes and to improve them.
Improving productivity. Productivity can be improved by spending money (capital) on better and faster machines and equipment. However, with any given amount
of capital, a method must be designed to use the machinery and equipment most productively. A workstation might consist of highly sophisticated machinery and equipment worth $1 million or more. Its productivity and return on investment depend on
how the equipment is used and how the operator manages it. CPI determines how
equipment is used and managed.
Continuous process improvement is a low-cost method of designing or improving work methods to maximize productivity. The aim is to increase productivity by
better use of existing resources. Continuous process improvement is concerned with
removing work content, not with spending money on better and faster machines.
Peter Drucker has said, “Efficiency is doing things right; effectiveness is doing
the right things.” CPI aims to do the right things and to do them efficiently.
People involvement. Today management recognizes the need to maximize the
potential of flexible, motivated workers. People are capable of thinking, learning,
problem solving, and contributing to productivity. With existing processes and equipment, people are the primary source of improvement because they are the experts in
the things they do.
Process improvement is not solely the responsibility of industrial engineers.
Everyone in the workforce must be given the opportunity to improve the processes
they work with. Techniques that help to analyze and improve work are not complicated and can be learned. Indeed, the idea of continuous improvement is based on
the participation of operators and improvement in methods requiring relatively little
capital.
Workers have two jobs:
• Their “as defined” job.
• To improve their “as defined” job.
Teams. One of the features of CPI is team involvement. A team is a group of people working together to achieve common goals and objectives. The members of the
team should be all those who are involved with the process. Teams are successful
because of the emphasis placed on people. Not all problems can be solved by teams,
nor are all people suited to teams. However, they are often effective. Often problems
cross functional lines and thus multifunctional teams are common.
Continuous process improvement can still be effectively carried out by the
individuals.
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Chapter 14
The Six Steps in Continuous Process Improvement
The CPI system is based on the scientific method. This general method is used to solve
many kinds of problems. The six steps are as follows:
1.
2.
3.
4.
5.
6.
Select the process to be studied.
Record the existing method to collect the necessary data in a useful form.
Analyze the recorded data to generate alternative improved methods.
By evaluating the alternatives to develop the best method of doing the work.
Install the method as standard practice by training the operator.
Maintain the new method.
Select the Process
The first step is to decide what to study. This depends on the ability to recognize situations that have good potential for improvement. Observation of existing methods
comes first.
Observe. The important feature in observation is a questioning attitude. Questions
such as why, when, and how must be asked whenever we observe something. This attitude needs development because we tend to assume that the familiar method is the
only one. Often we hear, “We have always done it this way!” “This way” is not necessarily the only, most productive, or most effective way.
Any situation can be improved but some have better potential than others.
Indicators that show areas most needing improvement include:
• High scrap, reprocessing, rework, and repair costs.
• Backtracking of material flow caused by poor plant layout.
• Bottlenecks.
• Excessive overtime.
• Excessive manual handling of materials, both from workplace to workplace and
at the workplace.
• Employee grievances without true assignable causes.
Select. The purpose of continuous process improvement is to improve productivity
to reduce operating, product, or service costs. In selecting jobs or operations for
method improvement, there are two major considerations: economic and human.
Economic considerations. The cost of the improvement must be justified. The
cost of making the study and installing the improvement must be recovered from the
savings in a reasonable time. One to two years is a commonly used period.
The job size must justify the study. Almost anything can be improved, but the
improvement must be worthwhile. Suppose a method improvement saves one hour
Products and Processes
413
on a job taking 5 hours, performed once a month or 12 times a year. The reduction in
time is 20% and the total time saved in a year is 12 hours. Another method improvement saves 1 minute on a job taking 10 minutes, performed 200 times per week. The
time saved in this case is only 10% but will be 11 * 200 * 52 , 60 = 173.32 hours
per year, a much higher rate of return on the investment made in the study.
The human factor. The human factor governs the success of method improvement.
The resistance to change, by both management and worker, must always be remembered.
Working situations characterized by high fatigue, accident hazards, absenteeism, and
dirty and unpleasant conditions should be identified and improved. Sometimes
it is difficult to give specific economic justification for such improvements, but the
intangible benefits are extensive and should weigh heavily in selecting studies.
Pareto diagrams. Pareto analysis can be used to select problems with the greatest
economic impact. The theory of Pareto analysis is the same as that used in the ABC
analysis discussed in Chapter 9. This theory says that a few items (usually about 20%)
account for most of the cost or problems. It separates the “vital few” from the “trivial
many.” Examples of the “vital few” are:
• A few processes account for the bulk of scrap.
• A few suppliers account for most rejected parts.
• A few problems account for most process downtime.
The steps in making a Pareto analysis are as follows:
1. Determine the method of classifying the data: by problem, cause, nonconformity, and so forth.
2. Select the unit of measure. This is usually dollars but may be the frequency of
occurrence.
3. Collect data for an appropriate time interval, usually long enough to include all
likely conditions.
4. Summarize the data by ranking the items in descending order according to the
selected unit of measure.
5. Calculate the total cost.
6. Calculate the percentage for each item.
7. Construct a bar graph showing the percentage for each item and a line graph of
the cumulative percentage.
EXAMPLE PROBLEM
A product has failed in the field a number of times. Data are collected according to
the type of failure with the following results: Type A—11, type B—8, type C—5, type
D—60, type E—100, type F—4, other—12. Construct a table summarizing the data in
descending order of magnitude. From this table, construct a Pareto diagram.
Chapter 14
Answer
Type of
Failure
Number of
Failures
Percent
Cumulative
Percentage
E
100
50.0
50.0
D
60
30.0
80.0
A
11
5.5
85.5
B
8
4.0
89.5
C
5
2.5
92.0
F
4
2.0
94.0
O (Other)
12
6.0
100.0
Total
200
100.0
TYPES OF FIELD FAILURES
100
100
85.5
PERCENT FREQUENCY
414
92
89.5
94
80
80
60
50
40
30
20
5.5
0
E
D
4
2.5
2
A
B
C
TYPE OF FAILURE
F
6
O
415
Products and Processes
Note that Pareto analysis does not report what the problems are, only where
they seem to occur. In the previous example, further investigation into the causes of
failure types E and D will give the best return for the effort spent. It is important to
select the categories carefully. For example, in the previous problem, if the location
of failures were recorded rather than the type of failure, the results would be quite
different and perhaps not significant.
Cause-and-effect diagram. Sometimes called a fishbone or an Ishikawa diagram, the cause-and-effect diagram is a very useful tool for identifying root causes.
Figure 14.8 shows such a diagram.
The fishbone diagram is best used by a group or team working together. It can
be constructed by discussion and brainstorming. The steps in developing a fishbone
diagram are:
1. Identify the problem to be studied and state it in a few words. For example, the
reject rate on machine A is 20%.
2. Generate some ideas about the main causes of the problem. Usually all probable root causes can be classified into six categories.
• Materials. For example, from consistent to inconsistent raw materials.
• Machines. For example, a well-maintained machine versus a poorly maintained one.
• People. For example, a poorly trained operator instead of a well-trained one.
• Methods. For example, changing the speed on a machine.
• Measurement. For example, measuring parts with an inaccurate gauge.
• Environment. For example, increased dust or humidity.
3. Brainstorm all possible causes for each of the main causes.
4. Once all the causes have been listed, try to identify the most likely root causes
and work on these.
MAIN
CAUSE C
MAIN
CAUSE B
MAIN
CAUSE A
PROBLEM TO
BE SOLVED
MAIN
CAUSE D
MAIN
CAUSE D
MAIN
CAUSE D
Figure 14.8 Cause-and-effect diagram.
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Chapter 14
Record
The next step is to record all the facts relating to the existing process. To be able to
understand what to record, it is necessary to define the process being studied. Recording
defines the process. The following must be determined to properly define the process.
• The process boundaries. All processes, big or small, begin and end somewhere.
Starting and ending points form the boundaries of the process. For example, the
starting point in the process of getting to work in the morning might be getting
out of bed. The ending point might be arrival at the desk or classroom.
• Process flow. This is a description of what happens between the starting and
ending points. Usually this is a listing of the steps taken between the start and
finish of the process. There are several recording techniques to help perform
this step. Some of these will be discussed later in this chapter.
• Process inputs and outputs. All processes change something. The things that are
changed are called inputs and they may be physical, such as raw materials, or
informational, such as data. Outputs are the result of what goes on in the
process. For example, raw materials are converted into something more useful
or data are manipulated to produce reports.
• Components are the resources used in changing inputs to outputs. They are
composed of people, methods, and equipment. Unlike process inputs, components do not become part of the output but are part of the process. For example, in producing a report the word processor, graphics program, computer,
printer, et cetera, are all components.
• Customer. Processes exist to serve customers and customers ultimately define
what a process is supposed to do. If customer needs are not considered, there is
a risk of improving things that do not matter to the users of the output.
• Suppliers are those who provide the inputs. They may be internal to the organization or external.
• Environment. The process is controlled or regulated by external and internal
factors. The external factors are beyond control and include customers’ acceptance of the process output, competitors, and government regulation. Internal
factors are in the organization and can be controlled.
Figure 14.9 shows a schematic of the system.
The next step is to record all facts relating to the existing method. A record is
necessary because it is difficult to record and maintain a large mass of detail in our
heads for the duration of the analysis. Recording helps us consider all elements of the
problem in a logical sequence and makes sure we do consider all the steps in the
process. The record of the present method also provides the basis for both the critical
examination and the development of an improved method.
Classes of activity. Before discussing some of the charts used, we should look at
the kinds of activities recorded. All activity can generally be classified into one of six
types. As a method of shorthand, there are six universally used symbols for these
417
Products and Processes
Figure 14.9 Schematic of a
process.
ENVIRONMENT
•Internal
•External
INPUT
(Suppliers)
PROCESS
(Work Steps)
OUTPUT
(Customers)
COMPONENTS
•People
•Methods
•Equipment
Operation. The main step in a process, method, or procedure.
Usually the part, material, or product is modified during the
operation.
Inspection. An inspection for quality or a check for quantity.
Where process can be measured, regulated, and controlled.
Movement. The movement of workers, material, equipment, or
information from place to place.
Storage. A controlled storage from which material is issued or
received.
Delay. A delay in the sequence of events; for example, material
waiting to be worked on.
Decision. Where a decision is made.
Figure 14.10 Classes of activity.
activities. The activities and symbols are shown in Figure 14.10. One of the activities
shown, decision, may not always be used. If not, a decision is usually considered an
operation.
Following are descriptions of some of the various charting techniques.
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Chapter 14
PART "B"
PART "A"
MAIN COMPONENT
TIME
5
OPERATION TIME
DESCRIPTION
3
OPERATION TIME
DESCRIPTION
1
OPERATION
DESCRIPTION
TIME
6
OPERATION TIME
DESCRIPTION
4
OPERATION TIME
DESCRIPTION
2
OPERATION
DESCRIPTION
TIME
7
OPERATION
DESCRIPTION
INSPECTION
TIME
8
OPERATION
DESCRIPTION
TIME
9
OPERATION
DESCRIPTION
PURCHASED PART
INSPECTION
Figure 14.11 Operations process chart.
Operations process charts. Operations process charts record in sequence only
the main operation and inspections. They are useful for preliminary investigation and
give a bird’s-eye view of the process. Figure 14.11 shows such a chart.
The description, and sometimes the times, for each operation are also shown.
An operations process chart would be used to record product movement.
Process flow diagram. A process flow diagram shows graphically and sequentially the various steps, events, and operations that make up a process. It provides a
picture, in the form of a diagram, of what actually happens when a product is made or
a service performed. In addition to the six symbols shown in Figure 14.10, others may
be used to show such things as rework and documentation. Figure 14.12 shows an
example of a process flow diagram. In this example, the process starts when the goods
are received and ends when a check is sent to the supplier.
419
Products and Processes
FILE UNTIL
INVOICE AND
PURCHASE
ORDER
RECEIVED
NO
APPROVE
FOR
PAYMENT
YES
RECEIVING
REPORT
RECEIVED
INVOICE AND
PURCHASE
ORDER ON
FILE?
VERIFY
INVOICE
MAIL
CHECK
SEND TO
ACCOUNTS
PAYABLE
PREPARE
CHECK
Figure 14.12 Process flow diagram.
Analyze
Examination and analysis are the key steps in continuous process improvement.
Although all the other steps are significant, they either lead up to, or result from, the
critical analysis. This step involves analyzing every aspect of the present method and
evaluating all proposed possible methods.
Find the root cause. Frequently it is difficult to separate symptoms from the root
causes of problems. Often symptoms are what we see and it is difficult to trace back to
the root cause. To find root causes you must have a questioning attitude. For the analyst,
“why” is the most important word. Every aspect of the existing method should be questioned. In “The Elephant’s Child,” from The Just-So Stories, Rudyard Kipling wrote:
I keep six honest serving-men
(They taught me all I know);
Their names are What and Why and When
And How and Where and Who.
Kipling personifies six words normally used as questions; they are also the
“serving men” of the methods analyst.
A rule of thumb common to many problem-solving methods says it is necessary
to ask (and answer) the “why” question up to five times before one reaches the root
cause of a problem.
Three approaches can help in examining:
• A questioning attitude. This implies an open mind, examining the facts as they are,
not as they seem, avoiding preconceived ideas, and avoiding hasty judgments.
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Chapter 14
• Examining the total process to define what is accomplished, how, and why. The
answers to these questions will determine the effectiveness of the total process.
The results may show that the process is not even needed.
• Examining the parts of the process. Activities can be divided into two major categories: Those in which something is happening to the product (worked on,
inspected, or moved) and those in which nothing constructive is happening to
the product (delay or storage, for example). In the first category, value is added
only when the part is being worked on. Setup, put away, and move, while necessary, add cost to the product but do not increase its value. They must be minimized. Value will be added when the product is being worked on but, again, the
goal is to maximize the productivity of these operations.
Develop
When developing possible solutions, there are four approaches to take to help
develop a better method.
• Eliminate all unnecessary work. Question why the work is being done in the first
place and if it can be eliminated.
• Combine operations wherever possible. Thus material handling will be reduced,
space saved, and the throughput time reduced. This is a major thrust of just-intime manufacturing.
• Rearrange the sequence of operations for more effective results. This is an extension of the previous approach. If sequences are changed, then possibly they can
be combined.
• Simplify wherever possible by making the necessary operations less complex. If
the questioning attitude is used, then complexity should be reduced. Usually the
best solutions are the simple ones.
Principles of motion economy. There are several principles of motion economy,
among which are the following:
1. Locate materials, tools, and workplace within normal working areas and preposition tools and materials.
2. Locate the work done most frequently in the normal working areas and everything else within the maximum grasp areas.
3. Arrange work so motions of hands, arms, legs, and so on are balanced by being
made simultaneously, in opposite directions, and over symmetrical paths. Both
hands should be working together and should start and finish at the same time.
The end of one cycle should be located near the start of the next cycle.
4. Conditions contributing to operator fatigue must be reduced to a minimum.
Provide good lighting, keep tools and materials within maximum working areas
(see Figure 14.13), provide for alternate sitting and standing at work, and
design workplaces of proper height to eliminate stooping.
421
Products and Processes
MAXIMUM WORKING AREA
(SHOULDER MOVEMENT)
NORMAL WORKING AREA
(FINGER, WRIST, AND
ELBOW MOVEMENTS)
Figure 14.13 Working areas.
Human and environmental factors. In addition to the principles of motion
economy, other important matters that influence human and environmental conditions must be considered. These include safety, comfort, cleanliness, and personal
care; so provision must be made for lighting, ventilation and heating, noise reduction,
seating, and stimulation.
Of these, stimulation may be less obvious. In highly repetitive work, workers may
become bored and dissatisfied, which may lead to emotional problems. A pleasant
environment created by attractive color schemes in plants or offices, location of windows, and music during working hours can do much to reduce stress and absenteeism.
Methods improvement is based on the concepts of scientific management. It
concentrates on the task and ways of removing work content (waste) from tasks. It
gives little consideration to the human being and higher-level needs, such as selfesteem and self-fulfilment, and work can become repetitive and boring. Job design is
an attempt to provide more satisfying meaningful jobs and to use the worker’s mental
and interpersonal skills. These improvements include the following.
Job enlargement expands a worker’s job by clustering similar or related tasks
into one job. For example, a job might be expanded to include a sequence of activities
instead of only one activity. This is called horizontal enlargement.
Job enrichment adds more meaningful, satisfying, and fulfilling tasks. The job
not only includes production operations but many setup, scheduling, maintenance,
and control responsibilities.
Job rotation trains workers to do several jobs so they can be moved from one
job to another. This is called cross-training.
All these factors help to produce a more motivated and flexible workforce. In
modern manufacturing, where quick response to customers’ needs is essential, these
characteristics can mean the difference between business success and failure.
Employee empowerment and self-directed teams assumes the workers have
more knowledge and responsibility for understanding and performing the work.
Empowering the workers to take more responsibility can lead to self-directed teams,
Chapter 14
where there is typically no supervisor. The workers themselves will understand what
is to be done and will manage their own activities to accomplish the required work
efficiently and effectively with little or no supervision.
Install
So far, the work done by the analyst has been planning. Now the plans must be put
into action by installing the new method.
In planning the installation, consideration must be given to the best time to
install, the method of installing, and the people involved. Then the analyst needs to be
sure that equipment, tooling, information, and the people are all available. At installation time, a dry run will show whether all equipment and tooling are working properly.
Training the operator is the most important part of the installation. If the operator has been involved in designing the method change, this should not be difficult.
The worker will be familiar and comfortable with the change and will probably feel
some sense of ownership.
Learning curve. Over time, as the operator does the tasks repetitively, speed will
increase and errors decrease. This process is known as the learning curve and is illustrated in Figure 14.14. Note there is no time scale shown. Depending on the task, a
worker may progress through the learning curve in a few minutes or, for high-skill
jobs, several months or years.
Maintain
Maintaining is a follow-up activity that has two parts. The first is to be sure that the
new method is being done as it should be. This is most critical for the first few days,
and close supervision may be necessary. The second is to evaluate the change to be
sure that the planned benefits are accomplished. If not, the method must be changed.
Figure 14.14 Learning curve.
OUTPUT
422
TIME
423
Products and Processes
KEY TERMS
Simplification 396
Standard 396
Modularization 397
Specialization 397
Product and market focus
397
Process focus 398
Focused factories 398
Simultaneous engineering
399
Concurrent engineering 400
Processes 401
Nesting 401
Mass customization 401
General-purpose machinery
404
Special-purpose machinery
404
Flow processing 404
Product layout 405
Intermittent manufacturing
405
Project or fixed position
manufacturing 406
Cost equalization point
(CEP) 409
Pareto analysis 413
Cause-and-effect diagram
415
Operations process charts
418
Process flow diagram 418
Job design 421
Job enlargement 421
Job enrichment 421
Job rotation 421
Employee empowerment
and self-directed teams
421
QUESTIONS
1. Describe simplification, standardization, and specialization. Why are they important and
why are they interrelated?
2. What are the advantages and disadvantages of standardization?
3. What are the advantages and disadvantages of specialization?
4. What are product focus and process focus based on? What is a focused factory?
5. What is the advantage to modular design?
6. How are production costs affected by:
a. Standard sizes?
b. Universal fit parts?
7. What are the two criteria for designing a product?
8. Why is product design important to operations costs?
9. Why is product design important to quality?
10. What is simultaneous engineering, and what are some of its advantages?
11. What is a process? What is process nesting?
12. What are the five basic factors that must be considered when designing a process?
13. Why are product design, quantity to produce, and process design intimately related?
14. Give four reasons why companies will make a product in-house and why they will
outsource.
15. Describe general-purpose and special-purpose machinery. Compare each for flexibility
of use, operator involvement, run time per piece, setup time, quality, capital cost, and
application.
16. What is flow processing, and what are its advantages and disadvantages?
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Chapter 14
17. What is intermittent processing and when is it used? Contrast it with flow processing.
18. When is project (fixed position) processing used?
19. Define fixed and variable costs and give examples of each in manufacturing. What is
total cost, and what is the equation for it?
20. What is the cost equalization point?
21. How can the variable cost be reduced? What does this do to the fixed costs, and what is
needed to economically justify this course of action?
22. What are the six steps in continuous process improvement?
23. Name and describe the two considerations in selecting a job to be studied.
24. What is a Pareto diagram, and why is it useful?
25. What is a cause-and-effect diagram, and why is it useful?
26. Why is it necessary to record?
27. Describe each of the following as it relates to recording:
a. Process boundaries.
b. Process flow.
c. Process inputs and outputs.
d. Process components.
e. Suppliers.
f. Environment.
28. What are the six symbols used in method analysis? Are there other symbols that can be
used?
29. Describe each of the following:
a. Operations process chart.
b. Process flow diagram.
30. What is the purpose of the analysis step? What is the basic question?
31. What are the four approaches that should be taken when developing a better method?
32. What are the four principles of motion economy?
33. Describe job design.
34. What is the learning curve?
35. What might be some of the advantages and disadvantages of self-directed work
teams?
36. How might the learning curve impact standard production times used for planning? How
would you possibly deal with this impact?
PROBLEMS
14.1 Select a product with which you are familiar. How do you think it might be redesigned to
make it easier to manufacture and possibly more useful to the user?
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Products and Processes
14.2 Given the following fixed and variable costs and the volumes, calculate the total and unit
costs.
Fixed
cost
Variable
cost
Volume
(units)
$200.00
$10.00
100
$200.00
$7.00
1000
$50.00
$15.00
20
$1,000.00
$1.00
2000
$500.00
$20.00
500
Total
cost
Unit
cost
14.3 A process costs $200 to set up. The run time is 5 minutes per piece and the run cost is
$30 per hour. Determine:
a. The fixed cost.
b. The variable cost.
c. The total cost and unit cost for a lot of 500.
d. The total cost and unit cost for a lot of 1000.
Answer.
a. Fixed cost = $200.00
b. Variable cost = $2.50
c. Total cost = $1450.00
Unit cost = $2.90
d. Total cost = $2.700.00
Unit cost = $2.70
14.4 A manufacturer has a choice of purchasing and installing a heat-treating oven or having
the heat treating done by an outside supplier. The manufacturer has developed the following cost estimates:
Fixed cost
Variable cost
Heat treat in-house
$28,000.00
$10.00
Purchase services
$0.00
$17.00
a. What is the cost equalization point?
b. Should the company have the heat treating done outside if the annual volume is
3000 units? 5000 units?
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c. What would be the unit (average) cost for the selected process for each of the volumes in b above?
Answer.
CEP is at 4000 units
3,000 units. Purchase. Unit cost = $17.00
5,000 units. In-house. Unit cost = $15.60
14.5 Bananas are on sale at the Cross Towne store for 69¢ per pound. They normally sell for
99¢ per pound at your corner store. If round-trip bus fare costs $2.80 to the Cross Towne
store, is it worth going? Discuss other ways of taking advantage of this bargain.
14.6 Given the following costs, which process should be used for an order of 400 pieces of a
given part? What will be the unit cost for the process selected?
Buy
Setup
Tooling
Labor/unit
Material/unit
Purchase cost
Process A
$40.00
$10.00
$4.00
$2.00
Process B
$180.00
$20.00
$3.75
$2.00
$6.10
14.7 The Light Company is planning on producing a new type of light shade, the parts for
which may be made or bought. If purchased, they will cost $2 per unit. Making the parts
on a semiautomatic machine will involve a $5000 fixed cost for tooling and $1.30 per unit
variable cost. The alternative is to make the parts on an automatic machine. The tooling
costs are $15,000, but the variable cost is reduced to 60¢ per unit.
a. Calculate the cost equalization point between buying and the semiautomatic
machine.
b. Calculate the cost equalization point between the semiautomatic and automatic
machines.
c. Which method should be used for expected sales of the following?
i. 5000 units
ii. 6000 units
iii. 8000 units
iv. 10,000 units
v. 25,000 units
d. What is the unit cost for the selected process for each of the sales in c above?
Answer.
i. Unit cost = $2.00
ii. Unit cost = $2.00
iii. Unit cost = $1.925
iv. Unit cost = $1.80
v. Unit cost = $1.20
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Products and Processes
14.8 A major mail order house collected data on the reasons for return shipments over a
three-month period with the following results: wrong selection 62,000, wrong size 50,000,
order canceled 15,000, wrong address 3000, other 15,000. Construct a Pareto diagram.
Part
Number
Percent
Cumulative
Percent
Total
14.9 A firm experienced abnormal scrap and collected data to see which parts were causing
the problem with the following results: part A—$5720, part B—$10,250, Part C—$820,
Part D—$1130, Part F—$700. Complete the following table listing the errors in
descending order of importance. Construct a Pareto diagram.
Part
Total
Number
Percent
Cumulative
Percent
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Figure 14.15 Ballpoint pen
assembly.
1
2
3
4
S/A – 1
5
6
14.10 Draw an operations process chart for the assembly of a ballpoint pen. The pen is made
from three subassemblies (see Figure 14.15):
1. upper barrel
2. cartridge
3. lower barrel
Operation 1 attach clip to upper barrel
2 insert button into upper barrel
3 insert rotor into upper barrel
4 press ball into tip of cartridge
5 insert tip into cartridge
6 fill cartridge with ink
Inspection 1 test cartridge
Operation 7 insert cartridge into upper barrel
8 slip spring over cartridge
9 screw lower barrel and upper barrel together
Inspection 2 test operation of pen
3 final inspection
14.11 Draw a process flow diagram for your activities from the time you wake up until you
arrive at work. Can you think of ways to improve the process?
15
Just-in-Time Manufacturing
and Lean Production
INTRODUCTION
In the past 20 years, manufacturing has become much more competitive and the
global economy is now a forceful reality. Countries such as Japan and others on the
Pacific Rim can produce goods of consistently superior quality and deliver them to
North American markets at a competitive price and schedule. They have responded
to changing market needs and often have detected those needs before the consumer.
The Walkman, developed by Sony, is an example of Japanese market awareness.
Because of such competition, North America has lost the edge in the manufacture of
such goods as radios, televisions, cameras, and ships.
How have the Japanese been able to do this? It is not because of their culture,
geography, government assistance, new equipment, or cheap labor, but because they
practice just-in-time manufacturing. Just-in-time (JIT) manufacturing is a philosophy
that relates to the way a manufacturing company organizes and operates its business.
It is not a magic formula or a set of new techniques that suddenly makes a manufacturer more productive. Rather, it is the very skillful application of existing industrial
and manufacturing engineering principles. The Japanese have not taught us new
tricks but have forced us to examine some of our basic assumptions and approach
manufacturing with a different philosophy.
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JUST-IN-TIME PHILOSOPHY
Just-in-time manufacturing is defined in many ways, but the most popular is the elimination of all waste and continuous improvement of productivity. Waste means anything
other than the minimum amount of equipment, parts, space, material, and workers’
time absolutely necessary to add value to the product. This means there should be no
surplus, there should be no safety stocks, and lead times should be minimal: “If you
can’t use it now, don’t make it now.”
The long-term result of eliminating waste is a cost-efficient, quality-oriented,
fast-response organization that is responsive to customer needs. Such an organization
has a huge competitive advantage in the marketplace. While the fundamental objective focused on waste reduction, the waste reduction, the approaches that were developed also led to rapid response to demand through reduction of lead times, increased
levels of quality, and lower production costs.
Adding Value
What constitutes value to the user? It is having the right parts and quantities at the
right time and place. It is having a product or service that does what the customer
wants, does it well and consistently, and is available when the customer wants it.
Value satisfies the actual and perceived needs of the customer and does it at a price
the customer can afford and considers reasonable. Another word for this is quality.
Quality is meeting and exceeding customers’ expectations.
Value starts in the marketplace when marketing must decide what the customer
wants. Design engineering must design the product so it will provide the required
value to the customer. Manufacturing engineering must first design a process to
make the product and then build the product according to certain specifications. The
loop is complete when the product is delivered to the customer. Figure 15.1 shows
this loop schematically. If any part of the chain does not add value for the customer,
there is waste.
Adding value to a product does not mean adding cost. Users are not concerned
with the manufacturer’s cost but only with the price they must pay and the value they
receive. Many activities increase cost without adding value and, as much as possible,
these activities should be eliminated.
MARKETPLACE
(CUSTOMER)
MARKET
RESEARCH
MANUFACTURING
Figure 15.1 Product development cycle.
PRODUCT
DESIGN
MANUFACTURING
ENGINEERING
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431
WASTE
Anything in the product development cycle that does not add value to the product is
waste. This section will look at the causes of waste in each element of the product cycle.
Waste Caused by Poor Product Specification and Design
Waste making starts with the policies set by management in responding to the needs
of the marketplace. Management is responsible for establishing policies for the market segments the company wishes to serve and for deciding how broad or specialized
the product line is to be. These policies affect the costs of manufacturing. For example, if the range and variety of product are large, production runs will be short and
then machines must be changed over frequently. There will be little opportunity to
use specialized machinery and fixtures. On the other hand, a company with a limited
product range can probably produce goods on an assembly-line basis and take advantage of special-purpose machinery. In addition, the greater the diversity of products,
the more complex the manufacturing process becomes, and the more difficult it is to
plan and control.
Component standardization. As stated in Chapter 14, companies can specialize
in the products they make and still offer customers a wide range of options. If companies standardize on the component parts used in the different models they make,
they can supply customers with a variety of models and options made from standard
components. Parts standardization has many advantages in manufacturing. It creates
larger quantities of specific components that allow longer production runs. This, in
turn, makes it more economical to use more specialized machinery, fixtures, and
assembly methods. Standardization reduces the planning and control effort needed,
the number of items required, and the inventory that has to be carried.
The “ideal” product is one that meets or exceeds customer expectations, makes
the best use of material, and can be manufactured with a minimum of waste (at least
cost). As well as satisfying the customer, the product’s design determines both the
basic manufacturing processes that have to be used and the cost and quality of the
product. The product should be designed so it can be made by the most productive
process with the smallest number of operations, motions, and parts and includes all of
the features that are important to the customer.
Chapter 14 discussed the principles of product design in more detail.
Waste Caused in Manufacturing
Manufacturing takes the design and specifications of the product and, using the manufacturing resources, converts them into useful products. First, however, manufacturing
engineering must design a system capable of making the product. They do so by selecting the manufacturing steps, machinery, and equipment and by designing the plant layout and work methods. Manufacturing must then plan and control the operation to
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produce the goods. This involves manufacturing planning and control, quality management, maintenance, and labor relations.
Toyota has identified seven important sources of waste in manufacturing. The
first four relate to the design of the manufacturing system and the last three to the
operation and management of the system:
1. The process. The best process is one that has the capability to consistently make
the product with an absolute minimum of scrap, in the quantities needed, and
with the least cost added. Waste, or cost, is added to the process if the wrong
type or size of machine is used, if the process is not being operated correctly, or
if the wrong tools and fixtures are used.
2. Methods. Waste is added if the methods of performing tasks by the operators
cause wasted movement, time, or effort. Activities that do not add value to the
product should be eliminated. Searching for tools, walking, or unnecessary
motions are all examples of waste.
3. Movement. Moving and storing components adds cost but not value. For example, goods received may be stored and then issued to production. This requires
labor to put away, find, and deliver to production. Records must be kept and a
storage system maintained. Poorly planned layouts may make it necessary to
move products over long distances, thus increasing the movement cost and possibly storage and record-keeping costs.
4. Product defects. Defects interrupt the smooth flow of work. If the scrap is not
identified, the next workstation receiving it will waste time trying to use the
defective parts or waiting for good material. Schedules must be adjusted. If the
next step is the customer, then the cost will be even higher. Sorting out or
reworking defects are also waste.
5. Waiting time. There are two kinds of waiting time: that of the operator and
that of material. If the operator has no productive work to do or there are
delays in getting material or instructions, there will be waste. Ideally, material
passes from one work center to the next and is processed without waiting in
queue.
6. Overproduction. Overproduction is producing products beyond those needed
for immediate use. When this occurs, raw materials and labor are consumed for
parts not needed, resulting in unnecessary inventories. Considering the costs of
carrying inventory, this can be very expensive. Overproduction causes extra
handling of material, extra planning and control effort, and quality problems.
Because of the extra inventory and work-in-process, overproduction adds confusion, tends to bury problems in inventory, and often leads to producing components that are not needed instead of those that are. Overproduction is not
necessary as long as market demand is met. Machines and operators do not
always need to be fully utilized.
7. Inventory. As we saw in Chapter 9, inventory costs money to carry, and excess
inventory adds extra cost to the product. However, there are other costs in carrying excess inventory.
Just-in-Time Manufacturing and Lean Production
433
To remain competitive, a manufacturing organization must produce better
products at lower cost while responding quickly to the marketplace. Let us look at the
role inventory plays in each of these steps.
A better product suggests one that has features and quality superior to others.
The ability to take advantage of product improvement opportunities depends on
the speed with which engineering changes and improvements can be implemented.
If there are large quantities of inventory to work through the system, it takes longer
and is more costly before the engineering changes reach the marketplace. Lower
inventories improve quality. Suppose that a component is made in batches of 1000
and that a defect occurs on the first operation. Eventually, the defect will be caught,
very often after several more operations have been completed. Thus, all 1000 pieces
have to be inspected. Because much time has elapsed since the first operation when
the defect occurred, it is also difficult to pinpoint the cause of the problem. If the
batch size had been 100 instead of 1000, it would have moved through the system
more quickly and been detected earlier—and there would only be 100 to inspect.
Companies can offer better prices if their costs are low. Lower inventories
reduce cost. Also, if work-in-process inventory is reduced, less space is needed in
manufacturing, resulting in cost savings.
Responsiveness to the marketplace depends on being able to provide shorter
lead times and better due date performance. In Chapter 6, we saw that manufacturing lead time depends on queue and queue depends on the number and the batch size
of the orders in process. If batch size is reduced, the queue and lead time will be
reduced. Chapter 8 noted that forecasts were more accurate for nearer periods of
time. Reducing lead time improves forecast accuracy and provides better order
promising and due-date performance.
Poke-Yoke (Fail Safe)
Poke-yoke was first introduced by Shigeo Shingo of Japan. It implies the concept of
removing faults at the first instance and making a process or product “foolproof.” Shingo
argued that statistical quality control does not prevent defects. He differentiated between
errors and defects; errors will always be made, but defects can be prevented. Corrective
action should take place immediately after a mistake is made, which implies 100%
inspection as soon as an action occurs. This inspection can take one of three forms: successive check, self-check, and source inspection. Successive check inspection is done by
the next person in the process who passes the information back to the worker who just
performed the operation who can then make any needed repair. Self-check is done by the
worker and can be used on all items where a sensory perception is sufficient. Scratches
and paint blobs are examples of these. Source inspection also is done by the individual
worker who, instead of checking for defects, checks for errors that will cause defects.
Poke-yoke tries to change either the process or its resources, thus eliminating the
need to rely on human experience and knowledge. Examples include the following:
• Use color-coded parts.
• Put a template over an assembled component to show operators where specific
parts go.
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• Use counters to tell an operator how many operations have been performed.
• Have one prong larger that the other so the electric plug will fit only one way.
This is common in electrical wiring.
JUST-IN-TIME ENVIRONMENT
Many elements are characteristic of a JIT environment. They may not all exist in a particular manufacturing situation, but in general they provide some principles to help in
the development of a JIT system. These can be grouped under the following headings:
•
•
•
•
•
•
•
•
Flow manufacturing.
Process flexibility.
Total quality management.
Total productive maintenance.
Uninterrupted flow.
Continuous process improvement.
Supplier partnerships.
Total employee involvement.
Flow Manufacturing
The just-in-time concept was developed by companies such as Toyota and some major
appliance and consumer electronic manufacturers. These companies manufacture
goods in a repetitive manufacturing environment.
Repetitive manufacturing is the production of discrete units on a flow basis.
In this type of system, the workstations required to make the product, or family of
products, are located close together and in the sequence needed to make the product.
Work flows from one workstation to the next at a relatively constant rate and often
with some materials handling system to move the product. Figure 15.2 shows a
schematic of flow manufacturing.
These systems are discussed in Chapter 14. They are suitable for a limited range
of similar products such as automobiles, televisions, or microwave ovens. Because
work centers are arranged in the sequence needed to make the product, the system is
not suitable for making a variety of different products. Therefore, the demand for the
family of products must be large enough to justify economically setting up the line.
Flow systems are usually very cost effective.
Figure 15.2 Flow
manufacturing.
WORKSTATIONS
Input
1
2
3
4
Output
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Just-in-Time Manufacturing and Lean Production
Figure 15.3 Functional
layout.
Saw
Grinder
Saw
Saw
Lathe
Lathe
Lathe
Grinder
Drill
Drill
Drill
Work cells. Many companies do not have a product line that lends itself to flow
manufacturing. For example, many companies do not have sufficient volume of specific parts to justify setting up a line. Companies with this kind of product line usually
organize their production on a functional basis by grouping together similar or identical operations. Lathes will be placed together as will milling machines, drills, and
welding equipment. Figure 15.3 shows a schematic of this kind of layout including
routing for a hypothetical product (saw, lathe, grinder, lathe, drill). Product moves
from one workstation to the other in lots or batches. This type of production produces long queues, high work-in-process inventory, long lead times, and considerable
materials handling.
Usually this kind of layout can be improved. It depends on the ability to detect
product flows. This can be done by grouping products together into product families.
Products will be in the same family if they use common work flow or routing, materials, tooling, setup procedures, and cycle times. Workstations can then be set up in
miniature flow lines or work cells. For example, suppose the product flow shown in
Figure 15.3 represents the flow for a family of products. The work centers required to
make this family can be laid out according to the steps to make that family. Figure
15.4 is a schematic of such a layout.
Parts can now pass one by one, or in very small lots, from one workstation to the
next. This has several benefits:
• Queue and lead times going through the cell are reduced drastically.
• Production activity control and scheduling are simplified. The cell has only one
work center to control as opposed to five in a conventional system.
• Floor space needed is reduced.
• Feedback to preceding operations is immediate. If there is a quality problem, it
will be found out immediately.
Figure 15.4 Work cell layout.
Saw
Lathe
Grinder
Drill
Lathe
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Work cells permit high-variety, low-volume manufacturing to be repetitive. For
work cells to be really effective, product design and process design must work
together so parts are designed for manufacture in work cells. Component standardization becomes even more important. Work cells are sometimes called cellular
manufacturing.
Process Flexibility
Process flexibility is desirable so the company can react swiftly to changes in the
volume and mix of their products. To achieve this, operators and machinery must
be flexible, and the system must be configured to be changed over quickly from one
product to another.
Machine flexibility. To achieve machine flexibility, it often makes more sense to
have two relatively inexpensive general-purpose machines than one large, expensive
special-purpose piece of equipment. Smaller general-purpose machines can be
adapted to particular jobs with appropriate tooling. Having two instead of one makes
it easier to dedicate one to a work cell. Ideally, the machinery should be low-cost and
movable. Figure 15.5 illustrates the concept.
Quick changeover. Quick changeover requires short setup times. Short setup
times also have the following advantages:
• Reduced economic-order quantity. The economic lot size depends on the setup
cost. If the setup time can be reduced, the lot size can be reduced. For example,
if the economic-order quantity is 100 units and the setup can be reduced to 25%,
the economic-order quantity decreases to 50. Inventory is cut in half, and queue
and lead times are reduced. Reductions in setup of even greater magnitude are
Machine
A
W
I
P
Machine
B
Large
Machine
C
W
I
P
Machine
D
W
I
P
Machine
E
Flow with Large-Capacity Nondedicated Equipment
Machine A
Small C1
Machine D
Machine B
Small C2
Machine E
Flow with Small-Capacity Dedicated Equipment
Figure 15.5 Large versatile equipment versus small dedicated equipment.
Just-in-Time Manufacturing and Lean Production
•
•
•
•
437
possible. The general opinion is that setup can be cut 50% by organizing the
work and having the right tools and fixtures available when needed. For example, in one instance, a changeover on a die press was videotaped. The operator
doing the changeover was not in view for more than 50% of the time! He was
away from the machine getting tools, dies, and so on. One system for setup
reduction, called the “four-step method,” claims that reductions of 90% can be
achieved without major capital expense. This is accomplished by organizing the
preparation, streamlining the setup, and eliminating adjustments.
Reduced queue and manufacturing lead time. Manufacturing lead time depends
mostly on the queue. In turn, queue depends on the order quantity and scheduling. Reducing setup time reduces the order quantity and queue and lead
times.
Reduced work-in-process (WIP) inventory. Work-in-process inventory depends
on the number of orders in process and their size. If the order quantity is
reduced, the WIP is reduced. This frees up more floor space, allowing work
centers to be moved closer together, thus reducing handling costs and promoting the creation of work cells.
Improved quality. When order quantities are small, defects have less time to be
buried. Because they are more quickly and easily exposed, their cause will more
likely be detected and corrected.
Improved process and material flow. Inventory acts as a buffer, burying problems
in processes and in scheduling. Reducing inventory reduces this buffer and
exposes problems in the production process and in the materials control system.
This gives an opportunity to correct the problems and improve the process.
Operator flexibility. Flexible machinery and flexible processes need flexible people to operate them. To achieve operator flexibility, people should not only be trained
in their own jobs but should also be cross-trained in other skills and in problemsolving techniques. Only with well-trained people can the benefits of process flexibility be realized.
Total Quality Management
Total quality management (TQM) is the subject of Chapter 16. This section will focus
on quality from the point of view of manufacturing.
Quality is important for two reasons. If quality is not present in what is supplied
to the customer and the product is defective, the customer will be dissatisfied. If a
process produces scrap, it creates disrupted schedules that delay supplying the customer, increases inventory or causes shortages, wastes time and effort on work centers, and increases the cost of the product.
Who is the user? Ultimately, it is the company’s customer, but the user is also
the next operation in the process. Quality at any one work center should meet or
exceed the expectations (needs) of the next step in the process. This is important in
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maintaining the uninterrupted flow of material. If defects occur at one work center
and are not detected until subsequent operations, time will be wasted, and the quantity needed will not be supplied.
For manufacturing, quality does not mean inspecting the product to segregate
good from bad parts. Manufacturing must ensure that the process is capable of producing the required quality consistently and with as close to zero defects as possible.
Manufacturing must do all it can to improve the process to achieve this and then
monitor the process to make sure it remains in control. Daily monitoring can best be
done by the operator. If defects are discovered, the process should be stopped, and
the cause of the defects corrected.
The benefits of a good-quality program are less scrap, less rework, less inventory (inventory just in case there is a problem), better on-time production, timely
deliveries, and more satisfied customers.
As the concepts of TQM evolved, several of the concepts were structured, formalized, and enhanced to eventually become six sigma quality. Several of the key
aspects of the quality approach are discussed in Chapter 16.
Quality at the source. Quality at the source means doing it right the first time
and, if something does go wrong, stopping the process and fixing it. People become
their own inspectors, personally responsible for the quality of what they produce.
Total Productive Maintenance
Traditional maintenance might be called “breakdown maintenance,” meaning maintenance is done only when a machine breaks down. The motto of breakdown maintenance is “If it ain’t broke, don’t fix it.” Unfortunately, breakdowns occur only when a
machine is in operation, resulting in disrupted schedules, excess inventory, and
delayed deliveries. In addition, lack of proper maintenance results in wear and poor
performance. For example, if a car is not properly maintained, it will break down, not
start, or perform poorly on the road.
For a process to continue to produce the required quality, machinery must be
maintained in excellent condition. This can best be achieved through a program of
preventive maintenance. This is important for more reasons than quality. Low workin-process inventories mean there is little buffer available. If a machine breaks down,
it will quickly affect other work centers. Preventive maintenance starts with daily
inspections, lubrication, and cleanup. Since operators usually understand how their
equipment should “feel” better than anyone else, it makes more sense to have them
handle this type of regular maintenance.
Total productive maintenance takes the ideas of total preventive maintenance
one step further. According to the eleventh edition of the APICS Dictionary, total
productive maintenance is “preventive maintenance plus continuing efforts to adapt,
modify, and refine equipment to increase flexibility, reduce material handling, and
promote continuous flow.” As such, it emphasizes the JIT principle of eliminating
waste.
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439
Uninterrupted Flow
Ideally, material should flow smoothly from one operation to the next with no delays.
This is most likely to occur in repetitive manufacturing where the product line is limited
in variety. However, the concept should be the goal in any manufacturing environment.
Several conditions are needed to achieve uninterrupted flow of materials: uniform
plant loading, a pull system, valid schedules, and linearity.
Uniform plant loading. Uniform plant loading means that the work done at each
workstation should take about the same time. In repetitive manufacturing, this is
called balancing the line, which means that the time taken to perform tasks at each
workstation on the line is the same or very nearly so. The result will be no bottlenecks
and no buildup of work-in-process inventory.
Pull system. Demand on a workstation should come from the next workstation.
The pull system starts at the end of the line and pulls product from the preceding
operation as needed. The preceding operation does not produce anything unless a
signal is sent from the following operation to do so. The system for signaling demand
depends on the physical layout and conditions in the plant. The most well-known
system is the Kanban system. The details vary, but it is basically a two-bin, fixedorder-quantity, order-point system. A small inventory of parts is held at the user
operation—for example, two containers (bins) of parts. When one bin is used up, it is
sent back to the supplier operation and is the signal for the supplier operation to
make a container of parts. The containers are a standard size and hold a fixed number of parts (order quantity). This system also makes the counting and control of WIP
inventory much easier.
Valid schedules. There should be a well-planned valid schedule. The schedule
sets the flow of materials coming into the factory and the flow of work through manufacturing. To maintain an even flow, the schedule must be level. In other words, the
same amount should be produced each day. Furthermore, the mix of products should
be the same each day. For example, suppose a company makes a line of dog clippers
composed of three models: economy, standard, and deluxe. The demand for each is
500, 600, and 400 per week, respectively, and the capacity of the assembly line is 1500
per week. The company can develop the schedule shown in Figure 15.6. This will satisfy demand and will be level based on capacity. However, inventory will build up and,
if there is no safety stock, a variation in demand will create a shortage. For example,
if there is a surge in demand for the deluxe model in week 1, none may be available
for sale in week 2.
An alternate schedule is shown in Figure 15.7. With this schedule, inventory is
reduced, and the ability to respond to changes in model demand increases. The number of setups increases, but this is not a problem if setup times are small. The idea can
be carried further by making some of each model each day. Now it would mean producing 100, 120, and 80 of each model each day. If the line has complete flexibility,
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Figure 15.6 Master
production schedule.
Week
Economy
0
Standard
600
Deluxe
800
Total
Figure 15.7 MPS leveled
by week.
On
Hand
Week
1
2
3
1500
300
1500
1200
1400
1500
1500
On
Hand
1
Economy
250
Standard
1500
2
3
500
500
500
300
600
600
600
Deluxe
200
400
400
400
Total
750
1500
1500
1500
these can be produced in the following mixed sequence of 15. This is repeated 20
times during the day for a total output of 300:
E: Economy
S: Standard
D: Deluxe
Sequence: ESD, ESD, ESD, ESD, SES
The company makes some of everything each day in the proportions to meet
demand. Inventories are at a minimum. If demand shifts between models, the assembly line can respond daily. This is called mixed-model scheduling. The schedule is leveled, not only for capacity, but also for material.
Linearity. The emphasis in JIT is on achieving the plan—no more, no less. This
concept is called linearity and is usually reached by scheduling to less than full capacity. If an assembly line can produce 100 units per hour, it can be scheduled for perhaps 700 units for an eight-hour shift. If there are problems during the shift, there is
extra time so the 700-unit schedule can be maintained. If there is time left over after
the 700 units are produced, it can be spent on jobs such as cleanup, lubricating
machinery, getting ready for the next shift, or solving problems.
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441
Continuous Process Improvement
This topic is an element in both JIT and TQM and was discussed in Chapter 14.
Elimination of waste depends on improving processes continuously. Thus continuous
improvement is a major feature of just-in-time manufacturing.
Supplier Partnerships
If good schedules are to be maintained and the company is to develop a just-in-time
environment, it is vital to have good, reliable suppliers. They establish the flow of
materials into the factory.
Partnering. Partnering implies a long-term commitment between two or more
organizations to achieve specific goals. Just-in-time philosophy places much emphasis
not only on supplier performance but also on supplier relations. Suppliers are looked
on as co-producers, not as adversaries. The relationship with them should be one of
mutual trust and cooperation.
There are three key factors in partnering.
1. Long-term commitment. This is necessary to achieve the benefits of partnering. It
takes time to solve problems, improve processes, and build the relationship need.
2. Trust. Trust is needed to eliminate an adversarial relationship. Both partners
must be willing to share information and form a strong working relationship.
Open and frequent communications are necessary. In many cases the parties
have access to each other’s business plans and technical information.
3. Shared vision. All partners must understand the need to satisfy the customer.
Goals and objectives should be shared so that there is a common direction.
If properly done, partnering should be a win–win situation. The benefits to the
buyer include the following:
• The ability to supply the quality needed all the time so there will be no need for
inbound inspection. This implies that the supplier will have, or develop, an
excellent process quality improvement program.
• The ability to make frequent deliveries on a just-in-time basis. This implies that
the supplier will become a just-in-time manufacturer.
• The ability to work with the buyer to improve performance, quality, and cost.
For a supplier to become a just-in-time supplier, a long-term relationship must
be established. Suppliers need to have that assurance so they can plan their
capacity and make the necessary commitment to a single customer.
In return, the supplier has the following benefits.
• A greater share of the business with long-term security.
• Ability to plan more effectively.
• More competitive as a just-in-time supplier.
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Supplier selection. Chapter 7 noted that the factors to be considered when
selecting suppliers were technical ability, manufacturing capability, reliability, aftersales service, and supplier location. In a partnership there are other considerations
based on the partnership relationship. They include the following:
1. The supplier has a stable management system and is sincere in implementing
the partnership agreement.
2. There is no danger of the supplier breaching the organization’s secrets.
3. The supplier has an effective quality system.
4. The supplier shares the vision of customer satisfaction and delighting the
customer.
Supplier certification. Once the supplier is selected, the next step is a certification process that begins after the supplier has started to ship the product.
Organizations can set up their own criteria for supplier certification or can use
one such as what has been developed by the American Society for Quality. This
emphasizes the absence of defects both in product and nonproduct categories
(e.g., billing errors) and use of a good documentation system, such as the ISO 9000
system.
Total Employee Involvement
A successful JIT environment can be achieved only with the cooperation and involvement of everyone in the organization. The ideas of elimination of waste and continuous improvement that are central to the JIT philosophy can be accomplished only
through people cooperating.
Instead of being receivers of orders, operators must take responsibility for
improving processes, controlling equipment, correcting deviations, and becoming
vehicles for continuous improvement. Their jobs include not only direct labor but
also a variety of traditionally indirect jobs such as preventive maintenance, some
setup, data recording, and problem solving. As discussed previously in this chapter,
employees must be flexible in the tasks they do. Just as machines must be flexible and
capable of quick changeover, so must the people who run them.
The role of management must change. Traditionally, management has been
responsible for planning, organizing, and supervising operations. Many of their traditional duties are now done by line workers. In a JIT environment, more emphasis is
placed on the leadership role. Managers and supervisors must become coaches and
trainers, develop the capability of employees, and provide coordination and leadership for improvements.
Traditionally, staff have been responsible for such things as quality control,
maintenance, and record keeping. Under JIT, line workers do many of these duties.
Staff responsibilities then become those of training and assisting line workers to do
the staff duties assigned to them.
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MANUFACTURING PLANNING AND CONTROL IN A JIT ENVIRONMENT
The philosophy and techniques of just-in-time manufacturing discussed in this chapter are related to how processes and methods of manufacture are designed. The
major responsibility for designing processes and methods lies with manufacturing and
industrial engineering. Manufacturing planning and control are responsible for managing the flow of material and work through the manufacturing process, not designing the process. However, manufacturing planning and control are governed by, and
must work with, the manufacturing environment, whatever it is. Figure 15.8 shows the
relationship.
This section will study the effect a JIT environment has on manufacturing planning and control. No matter what planning and control system is used, these four
basic questions have to be answered:
1.
2.
3.
4.
What are we going to make?
What do we need to make it?
What do we have?
What must we get?
The logic of these questions always applies, whether we are going to cook a
meal or make a modern jet aircraft. Systems for planning and control vary. The manufacturing planning and control system (manufacturing resource planning) discussed
in this text has proved effective in any manufacturing environment. The complexity of
Figure 15.8 JIT
manufacturing.
JIT MANUFACTURING
MANUFACTURING
PLANNING AND CONTROL
PROCESS DESIGN
Forecasting
Flow Manufacturing
Master Planning
Process Flexibility
Material Requirements Planning
Total Quality Management
Capacity Management
Uninterrupted Flow
Production Activity Control
Total Employee Involvement
Purchasing
Supplier Partnerships
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the manufacturing process, the number of finished items and parts, the levels in the
bill of material, and the lead times have made the planning and control problems
either simple or complex. If anything can be done to simplify these factors, the planning and control system will be simpler. In general, the JIT philosophy simplifies
these factors, thus making the planning and control problems easier.
The sections that follow will look at how the various parts of the manufacturing
planning and control system relate to a JIT environment. In general, JIT manufacturing does not make the manufacturing planning and control system obsolete but, in
some ways, does change the focus. The JIT process is not primarily a planning and
control system. It is a philosophy and a set of techniques for designing and operating
a manufacturing plant. Planning and control are still needed in JIT manufacturing.
Forecasting
The major effect that JIT has on forecasting is shortened lead time. This does not affect
forecasting for business planning or production planning, but it does for master production scheduling. If lead times are short enough that production rates can be matched to
sales rates, forecasting for the master production schedule becomes less important.
Production Planning
The JIT system emphasizes relationships with suppliers. One purpose of production
planning is to arrange for long lead-time purchases. The JIT process has the potential
for reducing those lead times, but more importantly it provides an environment in
which the supplier and buyer can work together to plan the flow of material.
Master Production Scheduling
Several scheduling factors are influenced by JIT manufacturing:
1. Master scheduling tries to level capacity, and JIT tries to level the schedule
based on capacity and material flow. Figure 15.9 illustrates the difference.
2. The shorter lead times reduce time fences and make the master production
schedule more responsive to customer demand. The ideal lead time is so short
that the company can respond to actual sales, not to forecast. Whether the company builds to a seasonal demand or to satisfy promotion, a forecast is still necessary. Planning horizons can also be reduced.
3. The JIT system requires a stable schedule to operate. This principle is supported by using time fences. These are established based on lead times and the
commitment of materials and resources. If lead times can be reduced through
JIT practices, the time fences can be reduced.
4. Traditionally, weekly time buckets are used. This gives manufacturing an organizational buffer to plan and organize actual work flow. Because of reduced
lead times and schedule stability, it is possible to use daily time buckets in a JIT
environment.
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Figure 15.9 MPS leveled
by capacity and by
material.
Level Capacity Schedule
Week
1
Model A
900
Model B
300
Model C
Total
1200
2
3
900
300
1200
1200
1200
Level Material and Capacity Schedule
Week
1
2
3
Model A
300
300
300
Model B
400
400
400
Model C
500
500
500
1200
1200
1200
Total
Material Requirements Planning
Material requirements planning (MRP) plans the material flow based on the bill of
material, lead times, and available inventory. Just-in-time practices will modify this
approach in several ways:
• The MRP time buckets are usually one week. As lead times are reduced and the
flow of material improved, these can be reduced to daily buckets.
• The MRP netting logic is based on generating order quantities calculated using the
planned order releases of the parent, the inventory on hand, and any order quantity logic used. In a pure JIT environment, there is no inventory on hand, and the
order quantity logic is to make exactly what is needed. Therefore, there is no netting required. If the lead times are short enough, component production occurs in
the same time bucket as the gross requirement, and no offsetting is required.
• Bills of material can frequently be flattened in a JIT environment. With the use
of work cells and the elimination of many inventory transactions, some levels in
bills of material become unnecessary.
Both MRP and JIT are based on establishing a material flow. In a repetitive manufacturing environment, this is set by the model mix and the flow rate. The product to
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be made is decided by the need of the following workstation, which is ultimately the
assembly line.
However, many production situations do not lend themselves to level scheduling and the pull system. Some examples are as follows:
•
•
•
•
Where the demand pattern is unstable.
Where custom engineering is required.
Where quality is unpredictable.
Where volumes are low and occur infrequently.
Capacity Management
Capacity planning’s function is to determine the need for labor, equipment, and
material to meet the priority plans. Leveling schedules should make the job easier.
Capacity control focuses on adjusting capacity daily to meet demand. Leveling should
make this task easier, but so will the JIT emphasis on cutting out waste and problems
that cause ineffective use of capacity. Linearity, the practice of scheduling extra
capacity, will improve the ability to meet priority schedules.
Inventory Management
Because the JIT system reduces the inventory in the system, in some respects this should
make inventory management easier. However, if order quantities are reduced and annual
demand remains the same, more work orders and more paperwork must be tracked, and
more transactions recorded. The challenge then is to reduce the number of transactions
that have to be recorded. One system used is called backflushing, or post-deduct.
Material flows from raw material to work-in-process to finished goods. In a postdeduct system, raw materials are recorded into work-in-process. When work is completed
and becomes finished goods, the work-in-process inventory is relieved by multiplying the
number of units completed by the number of parts in the bill of material. The system
works if the bills of material are accurate and if the manufacturing lead times are short.
All of this work on JIT elements not only reduces waste, which is a major target
of JIT, but also establishes an environment that allows for an effective alternative to
MRP in the environment.
The Impact on Effective Lot Sizing
MRP is often called a push system, meaning that the material needs are calculated
ahead of time (planned order releases) and, assuming there are no significant
changes to the plans, pushed out to the production system as a production order. The
“trigger” for the entire plan is the projection of the final product need, as represented
by the master production schedule (MPS). Part of the difficulty with MRP is that
often the plans are not effective because of problems or changes, including:
• Changes in customer requirements, both in timing and quantity.
• Supplier delivery problems, including timing, quantity, and quality.
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447
• Inaccurate databases that can make the plans invalid, depending on the nature
of the inaccurate data.
• Production problems, including:
• Absenteeism in the workforce.
• Productivity and/or efficiency problems.
• Machine downtime.
• Quality problems.
• Poor communication.
These problems generally promote an environment that, despite the best-made
plans, can allow for ineffective execution and a growth in inventory levels.
The Pull System
The pull system was developed as an alternative to classical “push” MRP. The underlying concept is not to preplan and generate schedules but instead to react to the final
customer order and produce only what is needed to satisfy demand and then only
when it is needed. Essentially, this system is much the same as the basic reorder point
system used for independent inventory. If this is the case, why can it work now when
it did not work effectively for so many years before MRP? MRP was primarily
designed as a more effective alternative to reorder points because reorder points did
not work well.
The major reason reorder points normally do not work well in a dependent
inventory environment is a significant violation of the assumption of relatively constant demand that allows a reorder point to work well in some independent inventory
environments. A simple example may help illustrate the problem.
Suppose the product is a specific model of bicycle. The bicycles are made in
batches, which is a typical mode of production for an assemble-to-order environment.
The batch size is 200 bicycles.
Now we look at an item of dependent inventory that is one level lower on the
bill of materials—the bicycle seat. Suppose it has a lot size of 300, a two-week lead
time, and, since we are examining the use of a reorder point, a reorder point of 80.
Example 1—In this case suppose we have an inventory of 290 seats. A new batch
of bicycles has just been ordered, requiring us to use 200 of the seats in a very short
time. We are left, therefore, with 90 seats—10 above the reorder point. We do not
reorder since the reorder point has not been reached. The 90 will stay in inventory
until the next order for the bicycles is generated, which may be a significant time.
When that order does come to build another 200 bicycles, we can only build
90 because that is the only inventory we have. We need to immediately order another
lot of 300, but it will be two weeks before they are available.
Example 2—Now let us assume we have less inventory—enough less that by
building the lot of 200 bicycles we will hit the seat reorder point. Suppose we have 270
seats. The order for 200 bicycles comes in, we use 200 seats, and the seat reorder
point is reached. That will cause us to immediately reorder. Two weeks later the
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300 seats arrive and are added to the 70 left in stock. We now have 370 seats that will
stay in inventory (costing a lot of money) until the next time we build the bicycles,
which may be a very long time.
As the example illustrates, the lot-sizing problem with dependent inventory often
results in either a crisis shortage or a replenishment of stock well before it is actually
needed. This example shows that the critical conditions causing the problem are the large
lot sizes and the long lead times, both of which are major targets of JIT waste reduction.
First, let us look again at the standard EOQ model that helps determine the
most economical lot size. It is, of course, the basic trade-off of inventory holding cost
and order cost, as described in detail in Chapter 10.
$
TOTAL COST
HOLDING COST
ORDER COST
0
EOQ
QUANTITY
A fundamental assumption of this model is that the two major costs involved
are known and relatively fixed. While this is essentially true with holding cost, it is not
true with order cost. If the order cost is equipment setup, then a major JIT effort is to
reduce this setup cost. If it is a purchased item, the major effort is to work with suppliers to reduce the cost and time of purchase order and delivery. With these efforts,
the order cost curve is driven downward and to the left, as in the following figure:
$
TOTAL COST
HOLDING COST
ORDER COST
0
EOQ
QUANTITY
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Just-in-Time Manufacturing and Lean Production
When these actions are taken, a new total cost curve based on the new order
cost curve is generated, resulting in a significantly smaller EOQ, as the following
figure illustrates:
$
OLD TOTAL COST
HOLDING COST
NEW TOTAL COST
ORDER COST
0
NEW EOQ
OLD EOQ
QUANTITY
This implies the economic-order quantities and the reorder points are very
small, meaning that we will be ordering frequently but in very small batches. Since the
actions are also taken at the final product level, there will be, in the preceding bicycle
example, frequent lots of a very small quantity of bicycles built requiring small lots of
seats frequently reordered.
If we are to reexamine the scenario with the bicycles and bicycle seats, we now
see the impact. The lot size for the bicycles is very small, as is the lot size for the
seats. Lead time to replenish the seats, also a target for JIT improvement, has
shrunken as well. Suppose the bicycle lot size is now 7 and the seat lot size is 10.
The reorder point for the seats is now zero. If we build one lot size of bicycles, we
will have not reached the seat reorder point, and it appears as if we do not have
enough seats to make another lot of bicycles. With such a small seat lot size, however, we can easily afford to keep two, three, or even more lots on hand (the number being dependent on the new replenishment lead time). We can therefore build
the next lot of bicycles with the second lot of seats while the first lot of seats is being
replenished.
The downside of the change. While the average inventory is clearly lower in the
small lot size scenario, there is a cost involved beyond the one-time cost to reduce the
order cost and the lead time. Given that the overall customer demand has not diminished, we will need to order batches to be built much more frequently since each
batch is smaller in size. Each time the inventory of a given batch gets close to the
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reorder point, we risk a stockout if the demand during the replenishment lead time
exceeds expectations. The following figure illustrates the condition:
QUANTITY
“Normal” EOQ/ROP Pattern
JIT Kanban Pattern
EXPOSURES TO STOCKOUTS
TIME
The Kanban System
With shortened lead times a constant goal in JIT, a system is needed to generate the
reorder point signal without having to rely on a formal, structured system that could
take time to react. The developers of the JIT concepts utilized a simple card system
called Kanban (often pronounced con-bon), which roughly translated from Japanese
means card or ticket.
The system works very simply. The Kanban signal (often a piece of cardboard)
identifies the material to which it is attached. The information on the Kanban will
often include:
•
•
•
•
Component part number and identification.
Storage location.
Container size (if the material is stored in a container).
Work center (or supplier) of origin.
How it works. The following figures illustrate the use of what is often called a
two-card Kanban system. The two types of cards are a production card (authorizing production of whatever part number is identified on the card in the quantity
specified) and a withdrawal card (authorizing the movement of the identified
material).
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Just-in-Time Manufacturing and Lean Production
At the start of the process there is no movement, since all the cards are attached
to full containers. It is only when a card is unattached that activity is allowed.
In this way the number of cards will clearly limit the inventory authorized to be at any
location.
Production Flow
Work
Center
1
Center #1
“Raw” Material
Work
Center
2
Finished
Production
Center #2
“Raw” Material
Finished
Production
“Steady-State”—no demand and no production
PRODUCTION CARD
MOVE CARD
At some point, a downstream process needs some of the parts produced by
work center 2 (in its “Finished Production” stock). It takes a container of the material, leaving the work center 2 production card with the center. This illustrates two
additional rules of the system—all material movement is in full containers (recall
that the container lot size is supposed to be very small) and Kanban cards
are attached to a work center. This initial movement is illustrated in the following
figure:
External
Demand
Work
Center
2
Work
Center
1
“Free” Production Card—
authorizes production to replace
withdrawn container
PRODUCTION CARD
MOVE CARD
The unattached production card is the signal to start the work center 2 production to replace the container that was taken. To do that work they need raw material,
which is in the containers in front of the work center with the move cards attached.
When that material is used to replace the work center 2 finished material, the raw
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material container is now empty and the associated move card is unattached, as
shown in the following figure:
Work
Center
1
Work
Center
2
1. Production container replaced
2. “Free” production card placed on new container
3. Move card on raw material container removed
and is now “free”
PRODUCTION CARD
MOVE CARD
The unattached move card authorized movement of material to replace the
material that was used. That material is found in the “finished goods” section of work
center 1. The operator (or material handler) will now move the material and place the
move card on the container as proof of the authorization to move the material. Before
doing so, however, they must remove the production card that had first authorized its
production. That represents another critical rule for Kanban: every container with material must have one, but only one, card attached. Therefore, when the move card is
attached the production card must be removed. That is illustrated in the following figure:
Work
Center
1
Work
Center
2
1. Full container from Center #1 moved to #2
2. Center #2’s move card attached
3. Center #1’s production card removed and
is now “free”
PRODUCTION CARD
MOVE CARD
Now, of course, there is an unattached production card for work center 1, allowing it to produce, using some of the raw material for work center 1 and freeing a move
card for that material, as shown in the following figure:
Work
Center
1
Work
Center
2
1. Center #1 produces part to refill container
2. Production card attached to container
3. Material usage empties raw material container
and “frees” move card that was attached
PRODUCTION CARD
MOVE CARD
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Just-in-Time Manufacturing and Lean Production
This process continues upstream even to the suppliers, who can also receive the
Kanban move cards as a signal for their next shipment to the facility.
Notice that there are no schedules with this system. Production and movement
of material are only authorized purely as a reaction to the utilization of material for
production downstream. The production of the final product may be the customer
taking material. In some facilities there is a final assembly schedule for customer
orders. In those facilities that may be the only formal schedule used.
Also note that the cards only circulate within and between work centers, as
shown in the following figure:
Work
Center
1
Work
Center
2
Move Card Movement
Production Card Movement
PRODUCTION CARD
MOVE CARD
Kanban rules. Even though there are no formal schedules in a Kanban system,
there is a fairly important set of rules. Those rules are summarized:
• Every container with parts shall have one, but only one, Kanban.
• There will be no partial containers stored. Every container will be filled, empty,
or in the process of being filled or emptied. This rule makes inventory accounting easy. You do not need to count parts—only containers and then multiply by
the container quantity.
• There will be no production or movement without an authorization in the form
of an unattached Kanban card.
Card Alternatives. Since the development and successful implementation of
Kanban systems in many facilities, many alternatives have been designed and implemented. Some of the alternative methods include:
• Single card systems. The single card is the production card, with the empty container serving as the move signal.
• Color coding of containers.
• Designated storage spaces.
• Computer systems, often with bar coding serving as the signal generator.
It should be noted that the method used is not important. What is important is that
there is a clear reactive signal to generate activity that everyone clearly understands.
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Using the Kanban System for Process Improvement
Because the Kanban system allows for a controlled inventory of relatively small containers, there is a great opportunity for using the system to promote continual process
improvement. Specifically, whenever the process is working smoothly for an extended
period of time, there is a possibility that there actually is too much inventory in the
system. The analogy that is often used is a river. If the water level is high enough, it
will cover all the rocks in the river and appear to be running smoothly without any
obstructions. The water in the analogy is inventory, and the rocks are process problems, including quality problems, worker skills, equipment breakdown, and so forth.
The approach is to gradually remove the water until the first “rock” is exposed,
thereby establishing a priority of the most important obstacle to work on. It would be
dangerous, of course, to remove too much “water” at a time, because the obstacles
may stop the flow altogether. This is where the small lot size of Kanban is a benefit.
Removal of one Kanban card will remove one container, and since the containers are
small, so too will be the impact of the removal. The important aspect of this is that
some process problem will ultimately emerge, signaling the next target for JIT
process improvement efforts.
This is not an easy approach to implement. What is implied is that every time a
process is working smoothly there may be too much inventory and what is needed is
to remove inventory until it “hurts.” That is certainly not a natural action for most
people, and the performance evaluation system needs to be altered to reflect this type
of activity.
LEAN PRODUCTION
Lean production is a concept that has evolved from JIT concepts over the past several
years. There were many less-than-successful implementations of JIT worldwide during
the 1980s, in spite of the well-documented advantages and benefits resulting from JIT.
There is strong evidence that many manufacturers, eager to take advantage of the documented advantages, attempted to implement JIT without first understanding the fully
integrated approach and impacts of such a highly integrated system. This condition led
to many disappointing implementations or outright failures of JIT during that period.
As is often the case when fundamental concepts are not fully understood, the
JIT concepts were viewed by many manufacturers as invalid or inappropriate for their
particular production environment. In the meantime, the development of highly integrated production systems was rapidly evolving. MRP was recognized to be an effective engine to drive an integrated enterprise-wide information system that is today
called ERP. Purchasing and logistics activities were similarly being integrated with
fundamental internal materials management principles into an enterprise-wide
approach, today called supply chain management. Similarly, the fundamental concepts of JIT evolved to an enterprise-wide perspective called lean production.
What was originally called JIT is still called JIT in the lean production
approach, for it implies the pull system used to deliver just what is needed just in time
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for the need. Lean production, on the other hand, implies understanding and correctly implementing the major enterprise-wide changes required to truly eliminate or
significantly reduce waste in the system. It is the system-wide philosophical approach
used to integrate the system toward an ultimate goal of maximized customer service
with minimal system waste.
Many of the changes were discussed in the earlier discussion of general JIT
approaches and are forced on the organization by one simple principle. The principle
is that removal or reduction of excessive inventory or capacity between activities in a
process, regardless of the reason that inventory or capacity existed, serves to force a
tighter coupling of the activities in the system. In other words, the organization must
be managed as a system instead of a set of relatively disjointed activities.
Since the time that lean manufacturing was introduced, many manufacturers
have successfully implemented at least some of the concepts. Many were companies
that were unsuccessful in their first attempt under the original JIT system. In many
cases, the major difference between their early failure and later success is primarily
that people now understand the forced system perspective more completely and are
making the appropriate organizational changes to make it work.
Some Lean Production Tools
Value stream mapping. Value stream mapping is a tool to map and understand
the flow of materials from supplier to customer, focusing on not only understanding
the current state of process and flow but also specifying the value-added and
non–value-added time of all process steps. This includes all activities, even the inprocess storage of inventory and key metrics for the process. This visible understanding of the current flow of activities allows for developing a future state map that will
significantly reduce waste, decrease flow time, and make the process flow more efficiently and effectively. Strategies can then be developed for specific actions that will
lead the operation toward the future state.
Kaizen. The kaizen event usually focuses on a fairly small part of the overall production process to improve that part of the process. It is a structured approach to
understand and redesign the process to meet specific process goals that are often part
of the overall implementation of a lean production system. Kaizen events are generally considered to be a major part of the overall approach to continuous improvement
for an operation. Since kaizen events are generally designed to be accomplished in
short periods of time (one to two weeks), the term kaizen blitz is frequently used.
Takt time. The takt time is sometimes thought of as the heartbeat of the overall
process. It is usually defined to be the rate of production that is synchronized with the
rate of customer demand. If the production process is well synchronized with
demand, the implication is that customer demand will be met with little or no excess
inventory or other forms of waste. Takt time is a common metric used to help design
a future state process during value stream mapping.
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5S approach. While originally developed from a series of Japanese words, a rough
English translation is Sort, Straighten, Shine, Standardize, and Sustain. In general it
is a structured approach to organizing the operation for more effectiveness and less
waste that is the overall goal of a lean production system.
• Sort—determine things that are needed and those not needed in the workplace.
Remove those that are not needed.
• Straighten—Put the necessary things in good order so they may be readily available when needed.
• Shine—Clean the area, and keep it clean.
• Standardize—Maintain the order and cleanliness that have been developed.
• Sustain—Train and develop attitudes to keep the orderliness as an expected and
ongoing part of the organization culture.
WHICH TO CHOOSE—MRP (ERP), KANBAN, OR THEORY OF CONSTRAINTS?
As the various systems are developed and promoted, proponents of each claim their
favorite to be “the answer” to maximizing service to the customer and minimizing
inventory and other process costs. There are, however, certain production and business environments in which one may provide better benefits and another may not
work as well. This brings to light the importance of understanding the business environment and developing a specific production strategy to best meet the needs of customers in that environment.
MRP (ERP)
Where it works best. MRP is by its very nature a forward-looking system. Based
on the Master Schedule, it “predicts” when products need to be made and projects
the need for component production or purchase at all levels based on a defined set of
parameters. Because of the forward-looking nature of the system, MRP can be very
effective in an environment with a great deal of variability and uncertainty. For example, it can handle variability of demand as well as, or better than, most other systems
and tends to be quite effective in dealing with product design changes and process
changes.
Where it is not as effective. MRP has one major disadvantage. It is highly data
dependent. It is not only critical to have a lot of data, but the data need to be both
accurate and timely on an ongoing basis. The burden on the infrastructure can be
high and costly. If the environment has a great deal of stability in product design,
process, and customer demand, the process can often be run just as effectively, or
perhaps even more effectively, by using a system not so data intensive.
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JIT (Kanban)
Where it works best. JIT and Kanban are almost the opposite of MRP from the
standpoint of the type of preferred environment. In the JIT approach, most of the
recommendations fall under the categories of eliminating or reducing the process
uncertainties and making production more stable and predictable. This makes sense
when it is realized that Kanban is a very reactive system. Very little is planned ahead.
Instead, Kanban causes replacement of material used in a totally reactive mode.
Product design can cause a real problem in a Kanban system. For these reasons
Kanban works best in a highly stable and predictable environment.
Where it is not as effective. Kanban can quickly fail in a highly volatile environment because of the reactive nature of the system. Volatility in customer demand,
processing problems, and extensive changes in product designs make it very difficult
for a Kanban system to work effectively.
Kanban does not plan production ahead of time but merely provides a signal to
replace what has been used. As part of a lean production system, there is also an implication that little excess inventory exists. If there is a change in product design, the reactive part of the system (kanban) has little advance notice of the change, meaning some
inventory of the old design may be left over and demand for the new design can exist
before any has been produced in the system. In addition, since the system relies on a
fairly small amount of in-process inventory, spikes in demand or even large trends in
demand can often run the system out of inventory with little chance to react.
Theory of Constraints (Drum-Buffer-Rope)
Where it works best. Since the TOC system has as its basis the identification and
effective management of a constraint, it assumes that such a constraint can be identified and will be a constraint long enough to be managed effectively. In operations
where that is the case, the concepts of TOC can bring great benefits to managing the
process, as has been proved in many operations.
Where it is not as effective. TOC may not be as effective where the constraint
cannot be easily identified or managed. If, for example, the product mix for the operation changes in such a way that the constraint may change many times a day, then it
may be virtually impossible to effectively manage a constraint, even if it can be identified. Much like JIT and Kanban, TOC probably works more effectively in a more
stable demand environment.
Hybrid Systems
As might be expected, some operations have managed to take the best features of
each system and combine them into hybrid systems.
Kanban and MRP. The combination of these two systems is becoming quite
common. An MRP system is used for advanced planning, including long lead-time
purchased materials, adding resources, and implementing product design changes.
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Once the MRP has the materials and resources “lined up,” however, Kanban is used
as an execution system, bringing with it the characteristics of rapid response to customer order and reduced inventory levels throughout the process.
JIT and TOC. JIT often promotes process improvements throughout the system,
but as TOC teaches, there is almost always one process that constrains the overall
throughput. This implies the TOC approach can help prioritize the areas of improvement, and JIT principles can help with this improvement. In this sense, the TOC concepts can be thought of as an effective approach to implementing the concepts of JIT
without trying to change everything at once.
SUMMARY
The just-in-time philosophy and techniques that seek the elimination of waste and
continuous improvement were developed for repetitive manufacturing and are perhaps most applicable there. However, many basic concepts are appropriate to any
form of manufacturing organization.
As noted in Chapter 14, in intermittent manufacturing, material is processed
at intervals in lots or batches, not continuously. It is characterized by large variation in product design, process requirements, and order quantities. In the extreme,
every job is made to customer specification, and there is no commonality in product design. General-purpose equipment is used to make products. A contract
machine shop is an example. However, many companies make a variety of standard products in small volumes manufactured either to stock or to customer order.
Many of these have families of products, and if these can be identified, work cells
can be set up.
No matter what the characteristics of the intermittent shop, several JIT principles can be applied:
•
•
•
•
•
•
•
Employee involvement.
Workplace layout.
Total quality control.
Total productive maintenance.
Setup time reduction.
Supplier relations.
Inventory reduction.
The JIT manufacturing environment requires a planning and control system.
The manufacturing resource planning system is complementary to JIT manufacturing. The way in which some functions are used changes to reflect the differences in
the manufacturing environment, but, in general, the functions performed in the MRP
II system are those that have to be done in a JIT planning and control system.
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KEY TERMS
Adding value 430
Waste 431
Poke-yoke 433
Work cells 435
Process flexibility 436
Machine flexibility 436
Quick changeover 436
Operator flexibility 437
Quality at the source 438
Total productive
maintenance 438
Uniform plant loading 439
Balancing the line 439
Valid schedule 439
Mixed-model scheduling 440
Linearity 440
Partnering 441
Supplier certification 442
Backflushing or post-deduct
446
Pull system 447
Kanban 450
Lean production 455
Value stream mapping 455
Kaizen 455
Takt time 455
5S approach 456
QUESTIONS
1. What is the definition of waste as it is used in this text?
2. What is value to the user? How is it related to quality?
3. What are the elements in a product development cycle? For what is each responsible?
4. Why is product specialization important? Who is responsible for setting the level of
product specialization?
5. What is meant by component standardization? Why is it important in eliminating waste?
6. Why is product design important to manufacturing? How can the design add waste in
manufacturing?
7. After a product is designed, what is the responsibility of manufacturing engineering?
8. Explain why each of the following are sources of waste:
a. The process
b. Methods
c. Movement
d. Product defects
e. Waiting time
f. Overproduction
9. Explain how inventory affects product improvement, quality, prices, and the ability to
respond quickly to the marketplace.
10. What is repetitive manufacturing? What are its advantages? What are its limitations?
11. What is a work cell? How does it operate? What conditions are necessary to establish
one? What are its advantages?
12. Why is process flexibility desirable? What two conditions are required?
13. Name and describe five advantages of low setup time.
14. What are the two reasons why quality is important?
15. What is quality for manufacturing? How is it obtained?
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16. Why is productive maintenance important?
17. What are the four conditions needed for uninterrupted flow? Describe each.
18. What is the difference between leveling based on capacity and leveling based on material flow?
19. Why would a JIT manufacturer schedule seven hours of work in an eight-hour shift?
20. Why are supplier relations particularly important in a JIT environment?
21. Why is employee involvement important in a JIT environment?
22. What are the differences in a master production schedule in a JIT environment?
23. What effect does a JIT environment have on MRP?
24. Describe the backflush or post-deduct system of inventory record keeping.
25. Why is there sometimes difficulty with the MRP system?
26. What is the major difference between the MRP push systems and the pull system?
27. What is the Kanban system? How does it work?
28. What is the difference between production cards and move cards?
29. Where does an MRP system work best?
30. Where does a Kanban system work best?
31. Where does a drum-buffer-rope system work best?
PROBLEMS
15.1 A company carries 10 items in stock, each with an economic-order quantity of $20,000.
Through a program of component standardization, the 10 items are reduced to 5. The total
annual demand is the same, but the annual demand for each item is twice what it was before.
In Chapter 10, we learned that the economic-order quantity varies as the square root of the
annual demand. Since the annual demand for each item is now doubled, calculate:
a. The new EOQ.
b. The total average inventory before standardization.
c. The total average inventory after standardization.
15.2 In problem 15.1, if the annual carrying cost is 20% per unit, what will be the annual savings in carrying cost?
15.3 A company has an annual demand for a product of 1000 units, a carrying cost of $20 per
unit per year, and a setup cost of $100. Through a program of setup reduction, the setup
cost is reduced to $10. Run costs are $2 per unit. Calculate:
a. The EOQ before setup reduction.
b. The EOQ after setup reduction.
c. The total and unit cost before and after setup reduction.
15.4 A company produces a line of golf putters composed of three models. The demand for
model A is 500 per month, for B is 400, and for C is 300. What would be the mixed model
sequence if some of each were made each day?
Answer.
ABC, ABC, ABC, ABA
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15.5 The following MPS summary schedule is leveled for capacity. Using the following table,
level the schedule for material as well.
Week
1
2
3
4
5
1
2
3
4
5
800
1600
1600
1600
1600
Model A
Model B
Model C
Total
Answer.
Week
Model A
Model B
600
Model C
1000
Total
1600
1600
800
1600
1600
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MURPHY MANUFACTURING
When Joe Vollbrach, vice president of operations for Murphy Manufacturing, was
given the CEO’s directive to investigate the lean production concepts and to implement them if appropriate, he was slightly apprehensive. Everyone knew, he thought,
that MRP was the best way to run a manufacturing operation, and they had been
pretty successful with their MRP system. Once he read a couple of books and a magazine article or two about JIT and lean production, however, he thought maybe there
was something to it and it sure seemed simple enough. Dozens of companies had
reported great reductions in inventory cost and other forms of waste, and with
Murphy Manufacturing having only five to six inventory turns per year, the prospect
of significant inventory reductions was very appealing.
Encouraged with the success stories and very mindful of the CEO directive, Joe
wasted no time. He put out the directive to all his people to implement lean production the way it was working in the book examples he had read. A few months later,
however, he was beginning to wonder about the truth of the success stories in those
books. The following are some of the examples of the complaints he was getting and
the problems he was facing.
KAREN, THE PURCHASING MANAGER: “Joe, this JIT and lean production are a disaster for us.
It’s not only costing us a lot more money, but the suppliers are getting real angry with us.
Since our raw material inventory had typically been high, you said we should order
smaller quantities and have it delivered just in time for its need. Sure, that cut down on
the raw material inventory, but that cost saving has been more than made up for with all
the increased cost. First, purchase orders are not cost free, and we’re making a lot more
of them. That’s also taking up a lot more of our buyer’s time. Then there’s the transportation cost. Since most of the trucking companies charge a lot more for less-than-full
truckloads, our costs are going sky-high with more frequent deliveries of smaller loads.
Combine that with expediting costs, and it gets really bad. Our schedules are changing
even more frequently, and without the raw material the production people are often asking for next-day delivery of material they need for a schedule change. We’re flying more
parts in, and you know how much that costs!
That’s not all. Our suppliers are really wondering if we know how to run our business. We’re changing that schedule to them much more frequently, and the only way they
can hope to meet our needs is to keep a lot of our inventory in their finished goods. That’s
costing them a lot of money in inventory holding costs as well as administrative costs to
manage the inventory and to process all our requests. They not only have more requests
from us, but it seems like everything is a rush order. They’re pressing us hard for price
increases to cover their increased cost to keep us as a customer. I’ve held most of them off
for a while but not much longer. Unfortunately, I agree with them, so it’s hard for me to
make any kind of logical argument to counter their requests for price increases.”
OSCAR, SUPERVISOR OF SHIPPING/RECEIVING: “If you’re going to keep this up I have to ask for
two more truck bays and about four more receiving clerks. There’s a lot more trucks
making a lot more deliveries. We can’t schedule perfectly when a truck will show up, so
many times during the day there are several trucks waiting for an open truck bay.
Production people are screaming at us because they see a certain truck and they know a
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463
critical part is on it, but we have to wait because the trucks currently in the bays being
unloaded also have critical parts. It seems like everything is critical these days. A couple
more bays with enough people to staff them will help, although it’s not the only answer.
I figure about a $3 million renovation to the receiving area and an increase in our budget
of about $500,000 ought to be about enough to keep us afloat, at least most of the time.
Oh, I forgot—better make that $600,000 more. I also need another records clerk to keep
up with the big increase in paperwork from all those deliveries.”
Joe was just finished taking a couple of aspirin to deal with that headache, when
Marsha, a production supervisor caught up with him:
“Joe, I don’t know where you came up with these silly ideas, but you’re killing us here.
This so-called ‘Kanban’ system is just plain stupid. It reminds me of the reorder points we
used before the MRP system, and we all know how much better MRP made things work.
I feel like I just slipped 35 years back in time. We all know our customers are a fickle
bunch who are always changing their minds on orders. We used to have visibility with the
change when we used MRP, but now all we have is what the final assembly area is working
on. That not only causes us big, inefficient downtimes for setup changes but also doesn’t
give us much time to get the materials we need to make the different parts. When we do
figure out what we need, most of the time our suppliers don’t have any in raw material
stock. Now we have to waste more time and energy to scream at the buyers. What makes
it even worse is your directive to eliminate finished goods. We not only don’t have material to make what we need half the time, but we’re not allowed to make what we can. It
would seem that would make sense, so that when a customer does request a certain model
we have in stock, at least that order wouldn’t end up being a crisis.
The crisis scenario I just described is what happens when everything else works.
When we have some other problems, such as a piece of equipment going down, the real
disaster hits. What little order we can force goes out the window and everyone starts
really getting uptight. And don’t talk about ‘preventive maintenance,’ either. We need
every piece of equipment running as much as we can to even come close to making the
orders we need.”
By the way, some of our best people are threatening to quit. Some are being paid
on a piece rate, and the lack of material combined with the directive to avoid finished
goods has cut seriously into their paychecks. Even the ones on straight hourly pay are
unhappy. All we supervisors are being evaluated on labor productivity and efficiency,
and our numbers are looking real bad. Naturally, we put the heat on the workers to do
better, but I’m not too sure they can do much about it most of the time.
And another thing while I have your attention—in some of our models we have a lot
of engineering design changes. The MRP system used to give us some warning, but now we
have none. Suddenly one of the engineers will show up and tell us to use a different part.
When we check with purchasing, often they’ve only just gotten the notification themselves
and have only just started to work with the suppliers for the part. Not only do we have to
obsolete all the old parts, but also we have to wait for the new ones. The salespeople are
even starting to scream at us.
While I’m on a roll here, you’ve got to do something with those quality control
people. We could deal with some scrap or rejected parts when we had plenty of inventory, but now we need every part in the place. Tell them to quit rejecting parts and let
us use them. At least we’ll have a better chance of shipping the order, even if it isn’t
perfect.
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Almost as soon as Marsha left, Valorie (the sales manager) came in. Joe braced
himself for more of a headache even before she spoke. The expression on her face
foreshadowed what she had on her mind:
“Joe, my job is to make sales and keep the customers happy. The sales have been going
fine, but our delivery stinks. Our on-time delivery record has fallen from 95% to less
than 50% in the past six months. Some of our customers are threatening to leave us, and
some are pushing for price cuts. According to them, our delivery record is so poor they
feel compelled to keep more of our inventory in their raw material stores to account for
their lack of faith in our delivery promises. They say that since it’s our fault they have
increased raw material inventory costs, we should compensate them with a price cut. It’s
pretty hard to argue with their logic. I’m sure we would do the same with our suppliers if
they treated us the way we’ve been treating our customers lately.
We all know our customers have to sometimes change orders to reflect what their
own customers want. Now, however, the changes are becoming more frequent and radical. It seems since we are so poor in delivery they order more in advance from us to
buffer the time for our late deliveries. Ordering further into the future gives them a lot
less certainty of what they really need, so naturally they have to change once they do
know. I may have to get another order-entry clerk to deal with all the changes, and if I do
you better believe I’ll let everyone know the extra expense is your fault!
The bottom line here is simple, Joe. You’ve got to get after your people to improve
the delivery drastically or we may be in big trouble, and soon.”
After Valorie left Joe’s secretary came in with a rush memo from the CEO:
“I just got the preliminary financial report for the last quarter, and for the first time in
over five years we show a loss—and it’s a big one. That details show sales goals have basically been met. The loss comes from a very large increase in expenses in virtually every
area in operations except a modest decrease in inventory cost. I’m calling an emergency
staff meeting for two o’clock today. Please be ready to explain the situation completely.”
As Joe shut his door to insulate himself from the complaints and to prepare for
the meeting, he began to wonder if some of the people who claimed that JIT and lean
production were a culturally based system impossible to implement outside of Japan
were correct. He knew most of the problems were related to his attempt to implement the new system. What, he wondered, went wrong, and what should he do about
it? These were certainly two critical questions that would be major parts of the
two o’clock meeting, and he needed good and complete answers. The CEO was reasonable and could deal with the fact that mistakes might have been made, but
she would expect a detailed analysis and complete action plan to get things back on
track. The aspirin was definitely wearing off, and it was less than an hour ago that he
took them!
Assignment
Prepare a complete and comprehensive report for Joe to use for his two o’clock meeting. This should include both the analysis of what went wrong and why, as well as a
comprehensive and time-phased plan to implement lean production the correct way.
If you do not think lean production is appropriate, explain why in detail and develop
a comprehensive alternative plan.
16
Total Quality Management
INTRODUCTION
The quality of a product or service is difficult to define since it is often viewed by people’s perceptions and measured against their own experiences. This chapter will cover
definitions of quality and how these can be used in the design of products and services
to meet customer expectations. Constant improvement in quality is the responsibility
of all members of an organization, and this chapter will introduce some management
practices such as quality function deployment, ISO 9000 standards, and Six Sigma,
which help to guide an organization in this improvement. Also included is a brief
introduction to process variation and its measurement, along with inspection and
benchmarking.
WHAT IS QUALITY?
We all know, or think we know, what quality is. But often it means different things to
different people. When asked to define quality, people’s responses are influenced by
personal opinion and perception. Answers are often general or vague, for example,
“It’s the best there is,” “Something that lasts a long time and gives good service,” and
“Something with style.”
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While the definitions of quality vary, the one we will use contains the most commonly accepted ideas in business today.
Quality means user satisfaction: that goods or services satisfy
the needs and expectations of the user.
To achieve quality according to this definition, we must consider quality and
product policy, product design, manufacturing, and final use of the product.
Quality and product policy. Product planning involves decisions about the products and services that a firm will market. A product or service is a combination of tangible and intangible characteristics that a company hopes the customer will accept
and be willing to pay a price for. Product planning must decide the market segment to
be served, the level of performance expected, and the price to be charged, and it must
estimate the expected sales volume. The basic quality level of a product is thus specified by senior management according to its understanding of the wants and needs of
the market segment.
Quality and product design. A firm’s studies of the marketplace should yield a
general specification of the product, outlining the expected performance, appearance,
price, and volume. Product designers must then build into the product the quality level
described in the general specification. They determine the materials to be used, dimensions, tolerances, product capability, and service requirements. If product designers do
not do this properly, the product or service will be unsuccessful in the marketplace
because it may not adequately satisfy the needs and expectations of the user.
Quality and manufacturing. At the least, manufacturing is responsible for meeting the minimum specifications of the product design. Tolerances establish the
acceptable limits and are usually expressed as the amount of allowable variation
about the desired amount. For example, the length of a piece of lumber may be
expressed as 7′6″ ⅛″. This means that the longest acceptable piece would be 7′6⅛″
and the shortest acceptable piece would be 7′5⅞″ long. If an item is within tolerance,
then the product should perform adequately. If it is not, it is unacceptable. However,
the closer an item is to the nominal or target value, the better it will perform and the
less chance there is of creating defects.
Quality in manufacturing means that, at a minimum, all production must be
within specification limits and the less variation from the nominal the better the quality. Manufacturing must strive to produce excellent—not merely adequate—
products. Every product or service produced will have some form of tolerance
expressed. For example, the weight of bars of soap, the frequency response of compact
disks, or the time spent waiting in line will all have a plus and minus tolerance.
Quality and use. To the user, quality depends on an expectation of how the product should perform. This is sometimes expressed as “fitness for use.” Customers do
not care why a product is defective, but they care if it is defective.
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The customer may need some introduction to the proper use of a product or
feature, especially with new products. A good example of this is a feature required on
some new cars that turns off the headlight when its adjacent signal is activated. This is
a safety feature that improves the visibility of the signal but customers, unaware of
that design feature, thought their vehicles had a defect in the lighting. It was recommended that the manufacturer improve the wording in the owner’s manual and introduce this improvement to the customer when purchasing the vehicle. If the product
has been well conceived, well designed (meets customer needs), well made, well
priced, and well serviced, then the quality is satisfactory. If the product exceeds the
customer’s expectations, that is superb quality.
Figure 16.1 shows the loop formed by product policy, product design, operations, and the user. Quality must be added by each link.
Quality has a number of dimensions, among which are the following:
• Performance. The primary operating characteristics, such as the power of an
engine. Performance implies that the product or service is ready for the customer’s use at the time of sale. The phrase “fitness for use”—that the product
does what it is supposed to do—is often used to describe this. Three dimensions
to performance are important: reliability, durability, and maintainability.
1. Reliability means consistency of performance. It is measured by the length of
time a product can be used before it fails.
2. Durability refers to the ability of a product to continue to function even
when subjected to hard wear and frequent use.
3. Maintainability refers to being able to return a product to operating condition after it has failed.
• Features. Secondary characteristics—little extras, such as remote control on
a VCR.
• Conformance. Meeting established standards or specifications. This is manufacturing’s responsibility.
• Warranty. An organization’s public promise to back up its products with a guarantee of customer satisfaction.
MARKETPLACE
(CUSTOMER)
MARKET
RESEARCH
OPERATIONS
Figure 16.1 Product development cycle.
PRODUCT
DESIGN
PROCESS
DESIGN
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• Service. An intangible generally made up of a number of things such as availability, speed of service, courtesy, and competence of personnel.
• Aesthetics. Pleasing to the senses; for example, the exterior finish or the
appearance of a product.
• Perceived quality. Total customer satisfaction based on the complete experience
with an organization, not just the product. Many intangibles, such as a company’s reputation or past performance, influence perceived quality.
• Price. Customers pay for value in what they buy. Value is the sum of the benefits the customer receives and can be more than the product itself. All the
dimensions listed are elements of value.
These dimensions are not necessarily interrelated. A product can be superb in
one or a few dimensions and average or poor in others.
TOTAL QUALITY MANAGEMENT (TQM)
TQM is an approach to improving both customer satisfaction and the way organizations do business. TQM brings together all of the quality and customer-related
process improvement ideas. It is people oriented. According to the eleventh edition
of the APICS Dictionary, “it is based on the participation of all members of an organization in improving processes, products, services, and the culture they work in.”
The objective of TQM is to provide a quality product to customers at a lower
price. By increasing quality and decreasing price, profit and growth will increase,
which will increase job security and employment.
TQM is both a philosophy and a set of guiding principles that lead to a continuously improving organization.
Basic Concepts. There are six basic concepts in TQM:
1. A committed and involved management directing and participating in the quality
program. TQM is a continuous process that must become part of the organization’s culture. This requires senior management commitment.
2. Focus on the customer. This means listening to the customer so goods and services meet customer needs at a low cost. It means improving design and
processes to reduce defects and cost.
3. Involvement of the total workforce. Total quality management is the responsibility of everyone in the organization. It means training all personnel in the techniques of product and process improvement and creating a new culture.
It means empowering people.
4. Continuous process improvement. Processes can and must be improved to
reduce cost and increase quality. (This topic was discussed in Chapter 14 and
will not be covered in this chapter.)
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5. Supplier partnering. A partnering rather than adversarial relationship must be
established.
6. Performance measures. Improvement is not possible unless there is some way to
measure the results.
These basic concepts will be discussed in more detail in the following sections.
Management Commitment
If senior management is not committed and involved, then TQM will fail. These managers must start the process and should be the first to be educated in the TQM philosophy and concepts. The chief executive officer and senior management should
form a quality council whose purpose is to establish a clear vision of what is to be
done, develop a set of long-term goals, and direct the program.
The quality council must establish core values that help define the culture of the
organization. Core values include such principles as customer-driven quality, continuous improvement, employee participation, and fast response. As well, the council
must establish quality statements that include a vision, mission, and quality policy
statement. The vision statement describes what the organization should become 5 to
10 years in the future. The mission statement describes the function of the organization: who we are, who our customers are, what the organization does, and how it does
it. The quality policy statement is a guide for all in the organization about how products and services should be provided. Finally, the quality council must establish a
strategic plan that expresses the TQM goals and objectives of the organization and
how it hopes to achieve them.
Customer Focus
Total quality management implies an organization that is dedicated to delighting the
customer by meeting or exceeding customer expectations. It means not only understanding present customer needs but also anticipating customers’ future needs.
A customer is a person or organization who receives products or services.
There are two types of customers, external and internal. External customers exist outside the organization and purchase goods or services from the organization. Internal
customers are persons or departments who receive the output from another person
or department in an organization. Each person or operation in a process is considered a customer of the preceding operation. If an organization is dedicated to
delighting the customer, internal suppliers must be dedicated to delighting internal
customers.
Customers have six requirements of their suppliers:
1. High quality level.
2. High flexibility to change such things as volume, specifications, and delivery.
3. High service level.
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4. Short lead times.
5. Low variability in meeting targets.
6. Low cost.
Customers expect improvement in all requirements. These requirements are
not necessarily in conflict. Low cost and high flexibility, for example, do not have to
be trade-offs if the process is designed to provide them.
Employee Involvement
TQM is organization-wide and is everyone’s responsibility. In a TQM environment,
people come to work not only to do their jobs but also to work at improving their
jobs. To gain employee commitment to the organization and TQM requires the
following:
1. Training. People should be trained in their own job skills and, where possible,
cross-trained in other related jobs. As well, they should be trained to use the
tools of continuous improvement, problem solving, and statistical process control. Training provides the tools for continual people-driven improvement.
2. Organization. The organization must be designed to put people in close contact
with their suppliers and customers, internal or external. One way is to organize
into customer-, product-, or service-focused cells or teams.
3. Local ownership. People should feel ownership of the processes they work with.
This results in a commitment to make their processes better and to continuous
improvement. They should be empowered.
Empowerment means giving people the authority to make decisions and take
action in their work areas without getting prior approval. For example, a customer
service representative can respond to a customer’s complaint on the spot rather than
getting approval or passing the complaint on to a supervisor. Giving people the
authority to make decisions motivates them to accomplish the goals and objectives of
the organization and to improve their jobs.
Teams. A team is a group of people working together to achieve common goals
or objectives. Good teams can move beyond the contribution of individual members
so that the sum of their total effort is greater than their individual efforts. Working
in a team requires skill and training, and to work in teams is part of total quality
management.
Continuous Process Improvement
This topic, an element in both JIT and TQM, was discussed in Chapter 14. Quality
requires continuous process improvement. If a product is excellent in one dimension,
such as performance, then improved quality in another dimension should be sought.
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Supplier Partnerships
Supplier partnerships are very important in both just-in-time manufacturing and total
quality management. This topic was discussed in some detail in Chapter 15.
Performance Measures
To determine how well an organization is performing, its progress must be measured.
Performance measures can be used to:
•
•
•
•
•
Discover which process needs improvement.
Evaluate alternative processes.
Compare actual performance with targets so corrective action can be taken.
Evaluate employee performance.
Show trends.
It is really not a question of whether performance measures are necessary but of
selecting appropriate measures. There is no point in measuring something that does
not give valid and useful feedback on the process being measured. There are many
basic characteristics that can be used to measure the performance of a particular
process or activity, such as the following:
• Quantity. For example, how many units a process produces in a period of time.
Time standards measure this dimension.
• Cost. The amount of resources needed to produce a given output.
• Time/delivery. Measurements of the ability to deliver a service or product on
time.
• Quality. There are three dimensions to quality measurements:
1. Function. Does the product perform as specified?
2. Aesthetics. Does the product or service appeal to customers? For example,
the percentages of people who like certain features of a product.
3. Accuracy. This measures the number of nonconformances produced. For
example, the number of defects or rejects.
Performance measures should be simple, easy for users to understand, relevant
to the user, visible to the user, preferably developed by the user, designed to promote
improvement, and few in number.
Measurement is needed for all types of processes. Some of the areas and possible measurements are as follows:
• Customer. Number of complaints, on-time delivery, dealer or customer
satisfaction.
• Production. Inventory turns, scrap or rework, process yield, cost per unit, time
to perform operations.
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Chapter 16
• Suppliers. On-time delivery, rating, quality performance, billing accuracy.
• Sales. Sales expense to revenue, new customers, gained or lost accounts, sales
per square foot.
QUALITY COST CONCEPTS
Quality costs fall into two broad categories: the cost of failure to control quality and
the cost of controlling quality.
Costs of Failure
The costs of failing to control quality are the costs of producing material that does not
meet specification. They can be broken down into:
• Internal failure costs. The costs of correcting problems that occur while the
goods are still in the production facility. Such costs are scrap, rework, and
spoilage. These costs would disappear if no defects existed in the product
before shipment.
• External failure costs. The costs of correcting problems after goods or services
have been delivered to the customer. They include warranty costs, field servicing of customer goods and all the other costs associated with trying to satisfy
customer complaints. External failure costs can be the most costly of all if the
customer loses interest in a company’s product. These costs would also disappear if there were no defects.
Costs of Controlling Quality
The costs of controlling quality can be broken down into:
• Prevention costs. The costs of avoiding trouble by doing the job right in the first
place. (Remember the old adage, “An ounce of prevention is worth more than a
pound of cure.”) They include training, statistical process control, machine
maintenance, design improvements, and quality planning costs.
• Appraisal costs. The costs associated with checking and auditing quality in the
organization. They include product inspection, quality audits, testing, and
calibration.
Investment in prevention will improve productivity by reducing the cost of failure and appraisal. Figure 16.2 shows the typical pattern of quality costs before and
after a quality improvement program. Investing in prevention will increase total costs
in the short run, but in the long run prevention will eliminate the causes of failure and
reduce total quality costs.
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140
Legend
FAILURE
RELATIVE QUALITY COST
120
APPRAISAL
PREVENTION
100
80
60
40
20
0
BEFORE
SHORT TERM
AFTER
Figure 16.2 Impact of quality improvement on quality-related costs.
VARIATION AS A WAY OF LIFE
Variability exists in everything—people, machines, or nature. People do not perform
the same task in exactly the same way each time, nor can machines be relied upon to
perform exactly the same way each time. No two leaves are alike. It is really a question of how much variability there is.
Suppose that a lathe made 100 shafts with a nominal diameter of 1 inch. If we
measured those shafts we would find that, while the diameters tended to cluster
about 1 inch, there were some smaller and some bigger. If we plotted the number of
shafts of each diameter, we would probably get a distribution as shown in Figure 16.3;
this forms a histogram.
Chance variation. In nature or any manufacturing process, we can expect to find
a certain amount of chance variation that is inherent in the process. This variation
comes from everything influencing the process but is usually separated into the following six categories.
1. People. Poorly trained operators tend to be more inconsistent compared with
well-trained operators.
2. Machine. Well-maintained machines tend to give more consistent output than a
poorly maintained, sloppy machine.
3. Material. Consistent raw materials give better results than poor quality, inconsistent, ungraded materials.
Chapter 16
Figure 16.3 Frequency
distribution (Histogram)
of shaft diameters.
30
25
NUMBER OF SHAFTS
474
20
15
10
5
0
0.997
0.998
0.999
1
1.001
1.002
1.003
SHAFT DIAMETERS (INCHES)
4. Method. Changes in the method of doing a job will alter the quality.
5. Environment. Changes in temperature, humidity, dust, and so on can affect
some processes.
6. Measurement. Measuring tools that may be in error can cause incorrect adjustments and poor process performance.
Dividing all possible variations into these six smaller categories makes it easier
to identify the source of variation occurring in a process. If a connection can be found
between variation in the product and variation in one of its six sources, then improvements in quality are possible.
There is no way to alter chance variation except to change the process.
If the process produces too many defects, then it must be changed.
Assignable variation. Chance is not the only cause of variation. A tool may shift,
a gauge may move, a machine may wear, or an operator may make a mistake. There
is a specific reason for these causes of variation, which is called assignable variation.
Statistical control. As long as only chance variation exists, the system is said to be
in statistical control. If there is an assignable cause for variation, the process is not in
control and is unlikely to produce a good product. As will be shown later in this chapter, the objective of statistical process control is to detect the presence of assignable
causes of variation. Statistical process control, then, has two objectives:
• To help select processes capable of producing the required quality with minimum defects.
• To monitor a process to be sure it continues to produce the required quality and
no assignable cause for variation exists.
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Total Quality Management
Patterns of Variability
The output of every process has a unique pattern that can be described by its shape,
center, and spread.
Shape. Suppose, instead of measuring the diameters of 100 shafts, we measured
the diameters of 10,000 shafts. If we plotted the distribution of the diameters of the
10,000 shafts, the results in Figure 16.3 would be smoothed out and we would have a
curve as shown in Figure 16.4. This bell-shaped curve is called a normal curve and is
commonly encountered in manufacturing processes that are running under controlled conditions. This curve exists in virtually all natural processes from the length
of grass on a lawn, to the heights of people, to student grades.
Center. We can see from Figure 16.4 that the normal distribution has most results
clustered near one central point, with progressively fewer results occurring away from
this center. The center of the distribution can be calculated as follows:
Let:
©x = sum of all observations
n = number of observations
m = arithmetic mean 1average or center2
Then:
©x
n
In the example we are using:
m =
©x = 10,000
n = 10,000
10,000
m =
= 1 inch
10,000
FREQUENCY
Figure 16.4 Normal
distribution.
CENTER
SHAPE
SPREAD
VALUE
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Chapter 16
Spread. To evaluate a process, we must know not only what the center is but also
something about the spread or variation. In statistical process control there are two
methods of measuring this variation: the range and the standard deviation.
• Range. The range is simply the difference between the largest and smallest
values in the sample. In the example shown in Figure 16.3, the largest value
was 1.003 inches and the smallest was .997 inch. The range would be
1.003 inch - .997 inch = .006 inch.
• Standard deviation. The standard deviation (represented by the Greek letter or sigma) may be thought of as the “average spread” around the center. A distribution with a high standard deviation is “fatter” than one with a low standard
deviation. Higher-quality products have little variation (a low standard deviation). The measurement of the standard deviation was discussed in Chapter 11
in the section on determining safety stock. We know that:
m ; 1 = 68.3% of observations
m ; 2 = 95.4% of observations
m ; 3 = 99.7% of observations
where:
m = mean or average
standard deviation
We can use the standard deviation to estimate the amount of variation (quality)
in a product.
Suppose in our example of the shafts that:
m = 1.000 inches
= 0.0016 inch
Applying standard deviation to the previous example we know that:
68.3% of the shafts will have a diameter of 1 inch ; .0016 inch112
95.4% of the shafts will have a diameter of 1 inch ; .0032 inch122
99.7% of the shafts will have a diameter of 1 inch ; .0048 inch132
PROCESS CAPABILITY
Tolerances are the limits of deviation from perfection and are established by the product
design engineers to meet a particular design function. For example a shaft might be specified as having a diameter of 1 inch ; .005 inches. Thus, any shaft having a diameter
from 0.995 inch to 1.005 inches would be within tolerance. In statistical process control
0.995 inch is called the lower specification limit (LSL) and is the minimum acceptable
level of output. Similarly 1.005 inches is called the upper specification limit (USL) and is
defined as the maximum acceptable level of output. Both the USL and the LSL are related
to the product specification and are independent of any process. The distance between the
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Total Quality Management
upper and lower specifications is often called the specification doorway. The doorway is
analogous to a tunnel with a vehicle (the process) passing through it. Parts of the vehicle
that are wider than the doorway will represent defective product or scrap. In this example it is not possible to change the width of the tunnel. Specifications are set by designers
and ultimately by the customer and are normally not challenged. It is up to the producer
to keep the spread of the process output well within these limits. Figure 16.5 illustrates
this. One process, having a narrow spread (low sigma), will produce product within the
specification limits. The other process, having a wide spread (high sigma), will produce
defects. The first process is said to be capable, the second is not.
Besides spread, there is another way a process can produce defects. If there is a
shift in the mean (average), defects will be produced. Figure 16.6 illustrates the concept.
In summary:
• The capability of the process is a measure of the process spread compared to
the specification limits.
• A process must be selected that can meet the specifications.
LSL
MEAN
UNACCEPTABLE
USL
UNACCEPTABLE
Figure 16.5 Effect of process spreads.
LSL
USL
SHIFT
OF
MEAN
UNACCEPTABLE
Figure 16.6 Effect of shift in the mean.
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Chapter 16
Figure 16.7 Cp index greater
than 1.
LSL
USL
TOLERANCE
PROCESS SPREAD
6
.995"
1.000"
1.005"
• Processes can produce defects in two ways, by having too big a spread (sigma)
or by a shift in the mean (average).
Process Capability Index (Cp)
The process capability index combines the process spread and the tolerance into one
index. It assumes the process is centered between the upper and lower specification
limits—that there has been no shift of the mean. As well, the index assumes that
processes are 6σ wide, representing 99.7% of the output of a normal process. If the
process spread is smaller than the specification doorway then the process is said to be
capable.
Cp =
USL - LSL
6
In the example used under process spread, the tolerance was 1.000 inch /.005 inch,
and the standard deviation of the process (σ) was .0016 inch.
Cp =
1.005 - .995
= 1.04
6 * .0016
If the capability index is greater than 1.00, the process is capable of producing
99.7% of parts within tolerance and is said to be capable. If CP is less than 1.00, the
process is said to be not capable. Because processes tend to shift back and forward, a
Cp of 1.33 has become a standard of process capability. Some organizations use a
higher value such as 2. The larger the capability index, the fewer the rejects and the
greater the quality. Figure 16.7 shows the concept of the capability index.
EXAMPLE PROBLEM
The specifications for the weight of a chemical in a compound is 10 .05 grams. If the
standard deviation of the weighing scales is .02, is the process considered capable?
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Total Quality Management
Answer
Cp =
10.05 - 9.95
= 0.83
6 * .02
The Cp is less than 1, and the process is not considered capable.
The process capability index indicates whether process variation is satisfactory,
but it does not measure whether the process is centered properly. Thus it does not
protect against out-of-specification product resulting from poor centering. In some
cases this is important to know.
Cpk Index
This index measures the effect of both center and variation at the same time. The philosophy of the Cpk index is that if the process distribution is well within specification
on the worst-case side, then it is sure to be acceptable for the other specification limit.
Figure 16.8 illustrates the concept.
The Cpk index is the lesser of:
1USL - Mean2
3
or
1Mean - LSL2
3
The greater the Cpk, the further the 3σ limit is from the specification limit and
the fewer rejects there will be.
Interpretation of the Cp index is as follows.
Cpk Value
Less than 1
1 to 1.33
Greater than 1.33
Figure 16.8 Cpk index.
Evaluation
Unacceptable process. Part of process distribution is
out of specification.
Marginal process. Process distribution barely within
specification.
Acceptable process. Process distribution is well within
specification.
LSL
USL
TOLERANCE
3
.995"
3
.998"
1.005"
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Chapter 16
EXAMPLE PROBLEM
A company produces shafts with a nominal diameter of 1 inch and a tolerance of
.005 inch on a lathe. The process has a standard deviation of .001 inch. For each of
the following cases calculate the Cpk and evaluate the process capability.
a. A sample has an average diameter of .997 inch.
b. A sample has an average diameter of .998 inch.
c. A sample has an average diameter of 1.001 inches.
Answer
1.005 - .997
.997 - .995
= 2.67 or =
= .667
3 * .001
3 * .001
Cpk is less than 1. Process is not capable.
1.005 - .998
.998 - .995
b. Cpk =
= 2.33 or =
= 1.00
3 * .001
3 * .001
a. Cpk =
Cpk is 1. Process is marginal.
c. Cpk =
1.005 - 1.001
1.001 - .995
= 1.33 or = or
= 2
3 * .001
3 * .001
Cpk is 1.33. Process is capable.
PROCESS CONTROL
Process control attempts to prevent the production of defects by showing that when
the standard deviation increases there is an assignable cause for variation.
We have seen that variation exists in all processes and that the process must be
designed so the spread will be small enough to produce a minimum number of
defects. Variation will follow a stable pattern as long as the system of chance causes
remains the same and there is no assignable cause of variation. Once a stable process
is established, the limits of the resulting pattern of variation can be determined and
will serve as a guide for future production. When variation exceeds these limits, it
shows a high probability that there is an assignable cause.
We have also seen that a process can produce defects if the spread is too great
or if the center or the average is not correct. Some method is needed to measure
these two characteristics continually so we can compare what is happening to the
product specification. This is done using the X (X bar) and R control chart.
Control Charts
Run charts. Suppose a manufacturer was filling bottles and wanted to check the
process to be sure the proper amount of liquid was going into each. Samples are
taken every half hour and measured. The average of the samples is then plotted on a
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Total Quality Management
Figure 16.9 Run chart.
SUBGROUP AVERAGE
20
15
10
5
0
1
3
5
7
9
SUBGROUP NUMBER
Sample Average
Nominal Value
chart as shown in Figure 16.9. This is called a run chart. While it gives a visual
description of what is happening with the process, it does not distinguish between system (chance) variation and assignable cause variation.
X (X bar) and R Chart. A control chart for averages and ranges (X and R chart)
tracks the two critical characteristics of a frequency distribution—the center and the
spread. Small samples (typically three to nine pieces) are taken on a regular basis
over time and the sample averages and range plotted. The range is used rather than
the standard deviation because it is easier to calculate. Samples are used in control
charts rather than individual observations because average values will indicate a
change in variation much faster. Figure 16.10 shows an example of an X and R chart.
Control Limits
Figure 16.10 also shows two dotted lines, the upper control limit (UCL) and the lower
control limit (LCL). These limits are established to help in assessing the significance
of the variation produced by the process. They should not be confused with specification limits, which are permissible limits of each unit of product (tolerances) and have
nothing to do with the process.
Control limits are set so that there is a 99.7% probability that if the process is in
control, the sample value will fall within the control limits. When this situation
occurs, the process is considered to be in statistical control and there is no assignable
cause of variation. The process is stable and predictable. This is shown on the left
portion of the chart in Figure 16.10. All the points lie within the limits and the process
is in statistical control. Only chance variation is affecting the process. However, when
assignable causes of variation exist, the variation will be excessive and the process is
Chapter 16
AVERAGE OF X
Upper Control Limit
Lower Control Limit
Upper Control Limit
RANGE
482
Figure 16.10
X and R control chart.
said to be out of control. This is shown on the right portion of the chart, which indicates something has caused the process to go out of control.
As explained, two types of changes can occur in a process:
• A shift in the mean or average. This might be caused by a worn tool or a guide
that has moved. This will show up on the X portion of the chart.
• A change in the spread of the distribution. If the range increases but the sample
averages remain the same, we might expect this kind of problem. It might be
caused by a gauge or tool becoming loose or by some part of the machine
becoming worn. This will show up on the R portion of the chart.
The X and R chart is used to measure variables, such as the diameter of a shaft,
which can be measured on a continual scale.
Control Charts for Attributes
An attribute refers to quality characteristics that either conform to specification or do
not; for example, visual inspection for color, missing parts, and scratches. A go-no-go
gauge is a good example. Either the part is within tolerance or it is not. These characteristics cannot be measured, but they can be counted. Attributes are usually plotted
using a proportion defective or p-chart.
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Total Quality Management
Other Quality Control Tools
In addition to some of the previously discussed tools such as histograms (page 473),
run charts (page 481), and X bar and R charts (page 481), there are five other simple
tools that are commonly used. These include:
1. Pareto charts. These charts are merely histograms that are reorganized in such a
way as to show the highest bar first and all others in descending order from high
to low. This approach allows one to easily focus on the most important issues.
2. Checksheets. These represent a very simple method to collect data. Once an
issue of interest has been determined (for example, customer complaints about
some product or service), the sources of the complaints are listed as they occur.
Whenever a complaint reason is repeated, a check is put beside the reason.
Over time the number of checks should show clearly the major source of complaint, thereby allowing action to focus on that major source.
3. Process flowcharts. These charts show in detail the steps required to produce a
product or service. Once the specific tasks are identified, data can be collected
about these tasks to determine bottlenecks or other types of problems that can
be corrected to improve the process involved.
4. Scatterplots. These merely show the relationship between two variables of interest. For example, a bank may want to know whether there is a relationship
between how long people have to wait in line and how satisfied they are with their
service by the bank. For each customer, they would obtain a measure of the wait
time and their satisfaction. They could then plot each person’s score with the wait
time on the horizontal axis and the satisfaction index on the vertical axis. Plotting
many customer scores would then provide an indication whether there is a relationship and also the possible strength of that relationship.
5. Cause-and-effect (fishbone) diagrams. These diagrams are used to plot out all
the potential causes for an identified problem (effect). As specific problems are
branched out from the major effect area, the result appears to look something
like a fishbone. The potential causes can then be researched to find the root
cause and correct it. Figure 16.11 shows the structure:
Material
Equipment
Measurement
EFFECT
(Quality Characteristics)
People
Methods
CAUSES (Process-related)
Figure 16.11 The structure for a cause-and-effect diagram.
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SAMPLE INSPECTION
Statistical process control monitors the process and detects when the process goes
out of control, thus minimizing the production of defective parts. Traditional inspection inspects the batch of parts after it is made and, on the basis of the inspection
accepts or rejects the batch. There are two inspection procedures: 100% and acceptance sampling.
A 100% inspection means testing every unit in the lot. This is appropriate when
the cost of inspection is less than the cost of any loss resulting from failure of the
parts—for example, when inspection is very easy to do or the inspection is part of the
process. A light bulb manufacturer could easily build a tester to see if every light bulb
lights, or a baker could visually inspect all products prior to packaging them. In cases
in which the cost of failure is exceptionally high, 100% inspection is vital. Products for
the medical and aerospace industry may be checked many times because of the
importance of product performance or the high cost of failure.
Acceptance sampling consists of taking a sample of a batch of product and using
it to estimate the overall quality of the batch. Based on the results of the inspection a
decision is made to reject or accept the entire batch. There is a chance that a good
batch will be rejected or a bad batch will be accepted. Sampling inspection is necessary under some conditions.
Reasons for sampling inspection.
inspection.
There are four reasons for using sample
1. Testing the product is destructive. The ultimate pull strength of a rope or the
sweetness of an apple can be decided only by destroying the product.
2. There is not enough time to give 100% inspection to a batch of product. On
Election Day, newscasters are eager to get coverage. Once a small percentage
of the votes are in, a guess is made of the final outcome, usually with some estimate of the error (say 19 times out of 20).
3. It is too expensive to test all of the batch. Market sampling is an example of this,
as are surveys of public attitude.
4. Human error is estimated to be as high as 20% when performing long-term repetitive
testing. There are good reasons to have a representative sample taken of a batch
rather than to hazard this high an error.
Conditions necessary for sampling inspection.
depends on the following conditions:
The use of statistical sampling
• All items must be produced under similar or identical conditions. Sampling the
incoming produce to a food-processing plant would require separate samples
for separate farmers or separate fields.
• A random sample of the lot must be taken. A random sample implies that every
item in the lot has an equal chance of being selected.
Total Quality Management
485
• The lot to be sampled should be a homogeneous mixture. This means that defects
will occur in any part of the batch. (The apples on the top should be the same
quality as the apples on the bottom!)
• The batches to be inspected should be large. Sampling is rarely performed on
small lots and is much more accurate in very large samples.
Sampling Plans
Sampling plans are designed to provide some assurance of the quality of goods while
taking costs into consideration. Lots are defined as good if they contain no more than
a specified level of defects, called the acceptable quality level (AQL). A plan is
designed to have a minimum allowable number (or %) of defects in the sample in
order to accept the lot. Above this level of defects, the lot will be rejected.
Selecting a particular plan depends on three factors:
Consumer’s risk. The probability of accepting a bad lot is called the consumer’s
risk. Since sampling inspection does not produce results with 100% accuracy, there is
always a risk that a lot containing more than the desired number of defects will be
accepted. The consumer will want to be sure that the sampling plan has a low probability of accepting bad lots.
Producer’s risk. The probability of rejecting a good lot is called the producer’s
risk. Since sampling involves probabilities, there is a chance that a batch of good
products will be rejected. The producer will want to ensure that the sampling plan has
a low probability of rejecting good lots.
Cost. Inspection costs money. The objective is to balance the consumer’s risk and
the producer’s risk against the cost of the sampling plan. The larger the sample, the
smaller the producer’s and consumer’s risks and the more the likelihood that good
batches will not be rejected and poor batches accepted. However, the larger the sample size, the greater the inspection cost. Thus there is a balance between the producer’s and consumer’s risks and the cost of inspection.
Example. For simplicity, a single sampling plan will be considered (there are others).
The plan will specify the sample size (n)—the number of randomly selected items to
be taken—from a given size of production lot (N). These will be inspected for some
known characteristic, and the plan will set a maximum allowable number of defective
products in the sample (c). If more than this number of defectives is found in the sample, the entire lot is rejected. If the allowable number of defects, or fewer, are found
in the sample the lot is accepted. Figure 16.12 illustrates an example of a single sampling plan.
The larger the sample, the smaller the producer’s and consumer’s risk and the
more the likelihood that good batches will not be rejected and poor batches
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Chapter 16
ACCEPT IF FOUR
OR FEWER
DEFECTS FOUND
IN SAMPLE
PRODUCTION LOT
SIZE
n=400
SAMPLE SIZE
n=50
c=4
REJECT IF FIVE
OR MORE
DEFECTS FOUND
IN SAMPLE
Figure 16.12 Sampling plan.
accepted. However, the larger the sample size, the greater the inspection cost. Thus
there is a trade-off between the producer’s and consumer’s risks and the cost of
inspection.
ISO 9000:2000
The International Organization for Standardization (ISO) has issued a series of
standards; the most recent version is ISO 9000:2000. Established in 1947, ISO continues to be a nongovernmental organization based in Geneva, Switzerland. The
acronym (ISO) is derived from the Greek “isos” meaning equality, and it is used in
many languages. The European Community (EC) has openly accepted the ISO standards, and they are becoming universally accepted, especially in North America.
Besides being a requirement for doing business in Europe, customers throughout the
world have come to expect a quality standard and to demand ISO certification of
their suppliers.
The two categories of ISO standards are technical standards and management
standards. Technical standards allow interchanging of parts such as light bulbs, nuts
and bolts, tire sizes, and electrical connectors. As discussed in Chapter 14, standardizing parts has many advantages to the production and marketing of products. ISO
9000:2000 is a management standard that defines how a company conducts its business, which helps it work and understand its suppliers and customers.
The standards are intended to prevent nonconformities during all stages of
business functions, such as purchasing, invoicing, quality, and design. Originally, they
were written for contractual situations between suppliers and customers in which the
supplier would develop a quality system that conformed to the ISO standards and was
satisfactory to the customer. The customer would then audit the system for acceptability. This resulted in multiple audits for different suppliers and different customers. Because of this, a third-party registration system was created to avoid duplicate work and to ensure consistency for all supplier–customer situations.
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Total Quality Management
Third-party registration system. A third party called a registrar assesses the
adequacy of the supplier’s quality system. When the system conforms to the registrar’s interpretation of the applicable ISO 9000 standard, the registrar issues a certificate of registration. The registrar continues to survey the supplier and makes full
reassessment every three or four years. The registrar is a “qualified” certifying agent
who has usually been accredited by the Registrar Accreditation Board, which is affiliated with the American Society for Quality (ASQ). The third-party registration
system ensures customers that a supplier has a quality system in place and that it is
monitored, thus eliminating the need for audits for each customer.
ISO 9000:2000 is designed around a process approach to management and is
based on eight principles that are closely aligned with Total Quality Management
(TQM):
1. Customer focus: understanding customer needs, striving to exceed customer
expectations.
2. Leadership: establishing direction, unity of purpose, and a supportive work
environment.
3. Involvement of people: ensuring that all employees at all levels are able to fully
use their abilities for the organization’s benefit.
4. Process approach: recognizing that all work is done through processes and managed accordingly.
5. System approach to management: expands on the previous principle in that
achieving any objective requires a system of interrelated processes.
6. Continual improvement: as a permanent organizational objective, recognizing
and acting on the fact that in all cases further improvement is possible.
7. Factual approach to decision making: acknowledging that sound decisions must
be based on analysis of factual data and information.
8. Mutually beneficial supplier relationships: synergy can be found in such
relationships.
A common misconception about ISO 9000 is that it applies only to the manufacturing sector. ISO’s intent, however, is that the standard can apply to any business.
An indication of this in the most recent version is the use of the term product realization. This is an update to the previously used term production system and can now
include service activities such as giving information, diagnosing a patient, or designing a building. Examples of services where ISO 9000 can be applied are:
hospitality
maintenance
financial
purchasing
utilities
communications
government
professional
transportation
technical
health care
trading
administration
scientific
education
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Chapter 16
Documentation
ISO does not provide the documentation but specifies generic requirements for
management that are typically grouped into four levels: policies (quality manual),
procedures, practice, and proof, as shown in Figure 16.13. Policies define what management wants to accomplish. Procedures are established and closely linked to the
policies to ensure that policies are incorporated in the activities of the organization.
Practice is the demonstration of procedures, and documentation is the proof that the
procedures have been carried out. Auditors closely monitor all these documented
activities to ensure that they are being followed. An example of a policy in a retail
environment may be the statement “Customers will be satisfied with the quality of
our products.” The resulting procedure could then be “A full refund will be issued,
provided proof of purchase, and the approval of the department supervisor.” The
practice would involve giving the department supervisor the authority to issue the
refund, and the proof would be documented by the proper filing of receipts and
returns.
ISO 9000:2000 covers all aspects of managing a business including operations,
administration, sales, and technical support. It puts in place a process approach for all
the day-to-day activities of generating products or services. Customers and suppliers
to an ISO-certified organization can be assured that consistent management
processes are in place and providing stability and continuous improvement in products and services.
Level 1: Policies (Quality Manual)
Showing the scope of the quality management
system, indexed to Level 2: Procedures.
1
Policy
Level 2: Procedures
What the firm does to meet Level 1: Policies,
indexed to Level 3.
Level 3: Practice
Work instructions and detailed
procedures on how work is accomplished.
Level 4: Proof
Records of what
was done.
Figure 16.13 ISO 9000 documentation pyramid.
2
Procedures
3
Practice
4
Proof
Total Quality Management
489
BENCHMARKING
Benchmarking is a systematic method by which organizations can compare their performance in a particular process to that of a “best-in-class” organization, finding out
how that organization achieves those performance levels and applying them to their
own organization. Continuous improvement, as discussed in Chapter 14, seeks to make
improvement by looking inward and analyzing current practice. Benchmarking looks
outward to what competitors and excellent performers outside the industry are doing.
The steps in benchmarking are these:
1. Select the process to benchmark. This is much the same as the first step in the
continuous improvement process.
2. Identify an organization that is “best in class” in performing the process you want to
study. This may not be a company in the same industry. The classic example is
Xerox using L. L. Bean, a mail order sales organization, as a benchmark when
studying its own order entry system.
3. Study the benchmarked organization. Information may be available internally, may
be in the public domain, or may require some original research. Original research
includes questionnaires, site visits, and focus groups. Questionnaires are useful
when information is gathered from many sources. Site visits involve meeting with
the “best-in-class” organization. Many companies select workers to be on a
benchmark team that meets with counterparts in the other organization. Focus
groups are panels that may be composed of groups such as customers, suppliers,
or benchmark partners, brought together to discuss the process.
4. Analyze the data. What are the differences between your process and the benchmark organization? There are two aspects to this. One is comparing the
processes and the other is measuring the performance of those processes
according to some standard. The measurement of performance requires some
unit of measure, referred to as the metrics. Typical performance measures are
quality, service response time, cost per order, and so forth.
SIX SIGMA
Modern equipment is becoming increasingly complex, often involving thousands of
components that must work reliably to ensure the entire system does not fail. Bill
Smith, a reliability engineer at Motorola Corporation, found that to function properly the company’s complicated systems required individual component failure rates
approaching zero. These extremely low rates were beyond the ability of inspectors to
measure, and Smith worked with others to develop the Six Sigma Breakthrough
Strategy aimed at defect rates of 3.4 parts per million:
• Scope: systematic reduction of process variability.
• Quality definition: defects per million possibilities.
490
Chapter 16
• Purpose: improve profits by reducing process variation.
• Measurement: defects per million possibilities.
• Focus: locating and eliminating sources of process error.
Six Sigma, however, is about more than just measurements of parts production. It
encourages companies to focus on improving all business processes. Process improvements result in reduced waste, costs, and lost opportunities, which all lead to higher
profits for the producer and benefits to the customer. The Six Sigma methodology
must be initiated by upper management since it sets the business goals of the company and guides the actions of all employees. Middle management is tasked with
translating the business goals into process goals and measures. Six Sigma is a highly
focused system of problem solving with two main elements: projects and project
managers. Figure 16.14 illustrates the eight essential phases of Six Sigma projects,
which may be expressed as DMAIC (design, measure, analyze, improve, and control).
When the project has been selected:
1.
2.
3.
4.
5.
Select the appropriate metrics or key performance output variables.
Determine how the metrics will be tracked over time.
Determine the current project baseline performance.
Determine the input variables that drive the key performance output variables.
Determine what changes need to be made to the input variables to positively
affect the key performance output variables.
6. Make the changes.
Figure 16.14 Six Sigma
responsibilities.
Six Sigma
Phase
Responsibility
1. Recognize
Management
2. Define
Management
3. Measure
Black Belts/ Green Belts
4. Analyze
Black Belts/ Green Belts
5. Improve
Black Belts/ Green Belts
6. Control
Black Belts/ Green Belts
7. Standardize
Management
8. Integrate
Management
491
Total Quality Management
Figure 16.15 Six Sigma
occurs when the process
doorway is twice the process
spread:
Cp =
USL - LSL
7 2
6
LSL
USL
Target
–6 –5 –4 –3 –2 –1 0
1
2
3
4
5
6
7. Determine if the changes positively affect the key performance output
variables.
8. If the changes positively affect the key performance output variables, establish
controls of the input variables at the new levels. If they do not, return to step 5.
From a technical perspective, Six Sigma is achieved when the process capability,
Cp, is equal to 2 or greater. That is, the specification doorway is twice the width of the
Six Sigma process spread, and the long-term failure rate would be 3.4 parts per million. With good controls in place the minor shifts in the process will be detected prior
to any defective parts being produced. Figure 16.15 shows this concept graphically.
Note that the process is well centered.
The experience and abilities of project managers are designated by terms from
karate. “Green Belts” have a specified amount of training and are required to complete
a cost-saving project of approximately $10,000. Black Belts have extensively more training and are expected to implement projects with savings in excess of $100,000. Master
Black Belts have even further training and usually have completed large-scale projects
with savings of $1,000,000. Most often Black Belts also require a master’s degree from an
accredited university. Only a small portion of a company’s managers will attain Master
Black Belt status, and they are tasked with the training and guidance of trainees.
The Six Sigma method is an extension to other business processes of basic statistical process control and can be compared to other quality initiatives, such as continuous improvement or ISO 9000. It does encourage companies to take a customer
focus and improve business processes through a series of well-defined steps and
responsibilities. Process improvement of any kind will lead to reduced waste,
decreased costs, and improved opportunities. It is the customer who ultimately enjoys
lower costs and enhanced quality.
QUALITY FUNCTION DEPLOYMENT
Quality function deployment or QFD is a decision-making technique used in the
development of new products or the improvement of existing products, which helps
ensure that the wants, needs, and expectations of the customer are reflected in a company’s designs. Organizations that ignore the relationship between what is provided
in their products and what a customer wants will not remain competitive. QFD was
originally developed in the 1960s by Dr.Yoji Akao and Dr. Shigeru Mizuno and has
been adopted by notable U.S. manufacturers, including: GM, Ford, DaimlerChrysler,
Chapter 16
IBM, Raytheon, Boeing, Lockheed Martin, and their suppliers. As defined in the
eleventh edition of the APICS Dictionary, it is “A methodology designed to ensure
that all the major requirements of the customer are identified and subsequently met
or exceeded through the resulting product design process.”
QFD works as follows. The needs of the customer are gathered using various
survey methods or by comparing a company’s own products against the competition’s.
These wants are referred to as the voice of the customer or VOC, which must be
translated into engineering specifications through a series of well-defined steps.
A House of Quality, as shown in Figure 16.16, is used to sort all the data into a structured
process that takes the customer requirements, prioritizes them, and sets the engineering target values for the new design.
Interactions
+ Strong Positive
* Weak Positive
– Strong Negative
o Weak Negative
+
Stability
Volume
5
Lid design
5
A = Competitor A
B = Competitor B
U = Us
Low
High
2
Tight-fitting lid
Insulation value
+
Competitive
Evaluation
Appearance
Heat retention
Customer Needs
–
+
+
Wall thickness
Coffee Mug
–
+
B
U
U
B
A
U
A
4
B
A
Volume
5
B
U
Appearance–Shape
5
Stability
Handle grip
4
A
Spilling
5
Ease of drinking
4
Drop test
U
B
U
Closure on lid
Diameter 80 mm
Hight 100 mm
J
J
J
w
z
z
U
B
U
A
3
Figure 16.16 House of Quality for a travel mug.
A
B
A
U
ABS plastic
Responsibility
3
Insulation value
Target Values
5
Wall thickness 3 mm
492
A
B
A
B
Total Quality Management
493
The House of Quality in Figure 16.16 is a simple example used for the design of an
insulated travel mug. On the left-hand side is a list of all the features that the customer
feels are important in the design of the travel mug. On the right-hand side is an evaluation of how the sample mug holds up against the competition, listed from low to high
and showing where the sample and the competition rank in each of the identified customer needs. In this example it seems the mug has a well-fitting lid and customers like
the handle design. However, the mug spills easily, is not very durable, doesn’t hold
enough liquid, and doesn’t insulate well. These are considered the “wants” of the customer. The “hows” of meeting these wants are listed near the top of the house with such
features as the thickness of the material used and the volume and stability of the mug.
The “roof” of the house is used to show the interaction of the features, and in this case
only strong negatives and positives are shown. A strong positive, such as the thickness
of the wall and the heat retention, shows that they are closely related to each other and
that an increase in the wall thickness leads to an increase in the insulation value. In the
center of the house, priorities are set by management showing where improvements
should be made and their relative importance. Technical specifications to meet the
desired features and priorities are entered at the bottom of the house along with a
responsibility code showing which department or person will work on the design of the
final product. In this case the design of our new product will be a short (100 mm) and
stout (80 mm) mug made of ABS plastic. The handle design will also be of ABS plastic,
which can be molded from the same plastic as the mug. The new design must make sure
that any of the negative interactions such as wall thickness and volume are considered.
When QFD is properly administered and good group decision making is used, it
will ensure that design targets and features will reflect the needs of the customers and
will avoid adding costs and features that are not required.
JIT, TQM, AND MRP II
Although the purposes of MRP II, JIT, and TQM are different, there is a close relationship among them. JIT is a philosophy that seeks to eliminate waste and focuses on
decreasing nonvalue-added activities by improving processes and reducing lead time.
TQM places emphasis on customer satisfaction and focusing the whole company to that
end. While JIT seems to be inward looking (the elimination of waste in the organization
and lead time reduction) and TQM outward looking (customer satisfaction), they both
have many of the same concepts. Both emphasize management commitment, continuous
process improvement, employee involvement, and supplier partnerships. Performance
measurement is necessarily a part of process improvement in both JIT and TQM. JIT
places emphasis on quality as a means of reducing waste and thus embraces the ideas of
TQM. TQM is directed to satisfying the customer, which is also an objective of JIT.
JIT and TQM are mutually reinforcing. They should be considered two sides of
the same coin—providing customers what they want at low cost.
MRP II is primarily concerned with managing the flow of materials into,
through, and out of an organization. Its objectives are to maximize the use of the
494
Chapter 16
PLAN
MRP II
Plan labor,
material, and
resources
DO
JIT
Produce
goods and
services
CUSTOMER
Sets the
standard and
produces
demand
TQM
Meets or exceeds customer expectations
Figure 16.17 MRP II, JIT, and TQM. Source: Adapted from Basics of
Supply Chain Management, APICS—The Ed. Soc. for Res. Mgt., Falls Church,
VA, 1997. Reprinted with permission.
organization’s resources and provide the required level of customer service. It is a
planning and execution process that must work with existing processes, be they good
or bad. JIT is directed toward process improvement and lead time reduction, and
TQM is directed toward customer satisfaction. Thus both JIT and TQM are part of
the environment in which MRP II must work. Improved processes, better quality,
employee involvement, and supplier partnerships can only improve the effectiveness
of MRP II. Figure 16.17 illustrates the relationship graphically.
KEY TERMS
Quality 466
Tolerances 466
Performance 467
Features 467
Conformance 467
Warranty 468
Service 468
Aesthetics 468
Perceived quality 468
Price 468
Empowerment 470
Internal failure costs 472
External failure costs 472
Prevention costs 472
Appraisal costs 472
Chance variation 473
Assignable variation 474
Statistical control 474
Shape 475
Center 475
Spread 476
Lower specification limit
(LSL) 476
Upper specification limit
(USL) 476
Process capability index 478
Cpk index 479
Run chart 481
X (X bar) and R chart 481
Control limits 481
Pareto charts 483
Checksheets 483
Process flowcharts 483
Scatterplots 483
Cause-and-effect (fishbone)
diagrams 483
100% inspection 484
Acceptance sampling 484
Consumer’s risk 485
Producer’s risk 485
ISO 9000:2000 486
Third-party registration
system 487
Six Sigma 489
Quality function
deployment 491
Voice of the customer
492
Total Quality Management
495
QUESTIONS
1. What is the definition of quality?
2. In which four areas must quality be considered? How do they interrelate?
3. Name and describe the eight dimensions to quality.
4. What is total quality management, and what are its objectives?
5. What are the six basic concepts of TQM?
6. What does customer focus mean? Who is the customer?
7. What is empowerment, and why is it important in TQM?
8. What are the three key factors in supplier partnerships?
9. What is the purpose of performance measurement?
10. Name and describe each of the costs of quality. What is the best way to reduce the costs
of quality?
11. What is chance variation? What are the causes of it? How can it be altered?
12. What is assignable variation?
13. What is a normal distribution? Why is it important in quality control?
14. What is the arithmetic mean or average?
15. What is meant by the spread? What are the two measures of it?
16. What percentage of the observations will fall within 1, 2, and 3 standard deviations of the
mean?
17. In which two ways can a process create defects?
18. What is tolerance, and how does it relate to the USL and LSL?
19. What is the purpose of the process capability index Cp and the Cpk? How do they differ?
20. What is the purpose of process control? What kind of variation does it try to detect?
21. What is a run chart?
22. What is an X and R chart?
23. What are upper and lower control limits?
24. What is the difference between variables and attributes?
25. When is it appropriate to use 100% inspection?
26. What is acceptance sampling? When is it appropriate to use?
27. What are the consumer’s risk and the producer’s risk?
28. Why was the third-party registration system established for ISO 9000 certification?
29. What is benchmarking, and how is it different from continuous improvement?
PROBLEMS
16.1 The specification for the length of a shaft is 12 inches ; .001 inch. If the process standard
deviation is .00033, approximately what percentage of the shafts will be within tolerance?
Answer.
There are approximately 99.7% of shafts within tolerance.
496
Chapter 16
16.2 In problem 16.1, if the tolerance changes to .0007 inch, approximately what percentage of the shafts will be within tolerance?
16.3 The specification for the thickness of a piece of steel is .5 inch ; .05″. The standard deviation of the band saw is .015. Using Cp, calculate whether the process is capable or not.
Answer.
Cp = 1.11. Process is marginally capable.
16.4 The specification for the weight of a chemical in a compound is .05. If the standard
deviation of the weighing scales is .02, is the process considered capable?
16.5 The specification for the diameter of a hole is .75 inch .015 inch. The standard deviation of the drill press is .007 inch. Using Cp, calculate whether the process is capable or
not.
16.6 If in problem 16.5 the process is improved so the standard deviation is .0035, is the
process capable now?
Answer.
Process is capable.
16.7 In problem 16.6, what is the Cpk when:
a. The process is centered on .75? Is the process capable?
b. The process is centered on .74? Is the process capable?
Answer.
a. Cpk = 1.43. Process centered on 0.75. The process is capable.
b. Cpk = .24. Process centered on 0.74. The process is not capable
16.8 A company fills plastic bottles with 8 ounces of shampoo. The tolerance is ± 0.1 ounces.
The process has a standard deviation of .02 ounces. For the following situations, calculate the Cpk and evaluate the process capability.
a. A sample has an average of quantity of 7.93 ounces.
b. A sample has an average of quantity of 7.98 ounces.
c. A sample has an average of quantity of 8.04 ounces.
16.9 Create a House of Quality for a product familiar to you and complete the House of
Quality form. Pick at least three different brands of the product to make the competitive
comparison. List at least three customer needs inherent in the products and three features that deliver these needs. Identify the interactions among the features and establish
target values for your new and improved product.
497
Total Quality Management
Interactions
Strong Positive
* Weak Positive
Strong Negative
o Weak Negative
Competitive
Evaluation
A Competitor A
B Competitor B
U Us
Customer Needs
Target Values
Low
High
498
Chapter 16
ACCENT OAK FURNITURE COMPANY
Accent Oak Furniture Company has been in business for more than 30 years, serving
customers in Chicago and the surrounding area. The business consists of three different divisions composed of a bannister division that manufactures and installs quality
oak railings, a custom furniture division that manufactures such crafted items as dining room suites, and a kitchen cabinet division.
Each division reports to a vice president who in turn reports to Frank Johnson,
the president and founder of the company. Total sales for all three divisions arc projected to reach $8 million for the current fiscal year.
Frank has been quite pleased with the performance of the custom furniture
division and the kitchen cabinet division, which together account for more than 85%
of the sales revenue. He does, however, have some concerns about the bannister division. This concern is based on last year’s profit performance and the first week of
August’s sales report for the installation crews (see Figure 1).
It is now the second week of August and the new installation market is just
starting up. Bannisters are installed in new homes in the fall when the homes are
nearly finished and ready for sale. There is some demand for bannisters throughout
the year for renovations. However, this business is also concentrated in the fall and
quickly dies off before Christmas.
On Monday, Frank met with Tom Smythe, the vice president of the bannister division, and voiced his concerns. Frank suggested that they meet again on Friday to discuss
some further actions to get back on track. Tom felt the concerns were a bit premature but
agreed grudgingly. Tom felt that some of his key people should attend, so Hank Strong,
the manufacturing supervisor; Brian Coulter, the sales manager; and Pete Harburg, who
was in charge of the five two-man installation crews, were invited to attend.
During the meeting, Tom asked each one of his people to describe their individual
concerns about the past week’s installation report.
Hank began by giving a brief outline of the manufacturing process that he was
responsible for in the plant.
Handrail Area
1. The oak was purchased in 16-foot lengths and inspected for any flaws or exces2.
3.
4.
5.
sive knots to ensure it was #1 grade.
Any rejects were sent to the cabinet division to be used for interior shelves or to
make spindles.
The approved boards were run through a multihead mill that planed the bottom
side and shaped the top and sides of the handrail.
They were inspected again for rough grain and any knots that could cause quality problems. Any rejects were then cut into shorter usable lengths for shorter
handrails or spindles.
The handrails were then sent to the drilling machine where the holes were automatically spaced and drilled by the operator on an industrial quality drill press.
Total Quality Management
499
Occasionally the operator inspects the dimensions of the holes using a dual
purpose go-no-go gauge. On one end of the gauge is a metal rod that is inserted
in the hole to measure the depth. The rod has a hatchmarked area that has
PASS stamped into the metal. If the top of the hole is in the PASS area, then the
hole dimension is considered okay. The other end of the gauge is long and
round and has three steps cut into the circumference. This makes the rod get bigger around at about 41 inch from the end and 12 inch from the end. If the first part
goes into the hole but not the middle, the hole is undersized. If the second step
but not the third enters the hole, the hole is of the correct diameter. The third
step indicates oversize.
6. The handrails are then sent for sanding and varnishing. A final inspection is
performed for appearance and finish. The handrail sections are then sorted by
length for full size and shorts.
Spindle Area
1. Oak is purchased, inspected, and cut to length. Approximately 5% also comes
from the handrail area.
2. Sections are placed on a planer and run through twice to give the square end
dimensions. Pieces are then placed into a pattern lathe, which provides the
product with the spindle design and tapered top end. The operator also lightly
sands the spindle while it is on the lathe.
3. An occasional inspection is performed using a go-no-go gauge. The inspection
procedure requires the operator to fit over the end of a spindle a gauge, which is
an aluminum bar with a specified hole size. The spindle will pass inspection if
1
1
4 to 2 inch of spindle protrudes through the gauge. The gauge is actually
marked with red paint outside the limits to assist the operator when inspecting.
4. The operator sets the preangled cutter to maintain the desired size of the spindle end.
5. The approved spindles are then sent to final sanding and varnishing and final
inspection.
Hank felt that his people did the best job possible given the wood and
machinery available.
Brian Coulter, the sales manager, felt that his people were certainly doing their
jobs since sales had increased at a rate of 15% over the last three years. One major
concern that Brian did have was the increased number of complaints from his major
customer, Lincoln Homes, for the quality of the installations. It has already told Brian
it will take its business elsewhere if the quality does not improve immediately.
Pete was the most vocal of the group, since his area was always getting the flack.
He felt his crews were being pushed as hard as possible but just couldn’t keep on plan.
Accent Oak bannisters are designed to be easily installed in the field even for custom
work. However, crews seem to have to refit every other piece and spend time chasing
defects. Pete recently started having his crew keep track of reasons why they were
over or under budget on each job.
500
Chapter 16
Frank angrily told his people that he didn’t care whose fault the problems were,
he just wanted them fixed yesterday and stomped out of the room.
Tom and his group had just recently completed a quality management course,
and all agreed that they might as well see if it could help them solve the problem and
get Frank off their backs.
Figure 1 Installation Department Monthly Report—August 8.
Job#
Crew#
Budget
$
Actual
$
7156
1
1,100
1,127
Waited 1/2 hr for customer
7157
2
985
1,154
Fit problem with spindles
7158
5
1,200
996
7160
4
1,500
1,854
Recalled for loose spindle
7163
2
850
1,854
Two split spindles
7166
5
1,200
1,385
Fit problem with spindles
7167
1
1,450
1,620
Customer changed design refit
7168
4
1,800
2,254
Spindle shims needed
7169
5
1,100
1,080
7171
2
980
1,200
Handrail rough finish
7172
4
1,560
1,860
Loose spindles
7174
1
1,200
1,650
Not to drawings
7175
2
975
1,320
Handrail cracked
7177
4
1,400
1,875
Fit problem spindles
7179
3
2,250
3,200
Recalled for loose bannister
7181
5
1,900
2,520
Fit problem spindles
7182
3
1,800
2,260
Fit problem spindles
7184
3
1,750
1,780
Customer changed design
$25,000
$30,000
TOTAL
Comments
Inspection Report—Spindle
Figure 2 shows the specified depth and allowable tolerance for the pilot study on
spindle fit using the knife-edge gauge designed for this purpose. The following 50
readings have been taken and recorded as of August 14.
501
Total Quality Management
Figure 2
Spindle Test
B
Dimension A
A 65 +/– 10 inches
B 1 inch
Figure 3
Spindle Widths—Inches
.60
.63
.60
.62
.60
.59
.61
.67
.57
.61
.62
.59
.61
.64
.67
.66
.69
.63
.69
.68
.61
.67
.68
.67
.60
.61
.68
.60
.62
.60
.66
.60
.63
.62
.68
.67
.62
.70
.67
.68
.58
.68
.67
.69
.58
.69
.65
.68
.59
.64
Figure 4
Hole Diameters—Inches
.57
.56
.58
.59
.57
.58
.56
.58
.56
.58
.58
.59
.60
.55
.61
.60
.58
.57
.58
.60
.56
.61
.57
.59
.58
.57
.55
.57
.59
.57
.60
.58
.56
.60
.56
.62
.59
.58
.62
.59
.57
.62
.59
.61
.63
.59
.64
.60
.61
.63
502
Chapter 16
Case Analysis
1. Analyze the customer complaints using Pareto analysis to identify the largest cause of
complaints.
2. Construct histograms of the spindle and hole data to see if there is assignable cause to
the problem.
3. Complete the three following office memos with your recommendations.
INTEROFFICE MEMO
TO: Lead Hand—Handrail
FROM: Hank Strong
SUBJECT: Customer Complaints—Bannisters
INTEROFFICE MEMO
TO: Lead Hand—Spindle Department
FROM: Hank Strong
SUBJECT: Customer Complaints—Bannisters
INTEROFFICE MEMO
TO: Tom Smythe
FROM: Hank Strong
SUBJECT: Customer Complaints—Bannisters
DATE: August 17
DATE: August 17
DATE: August 17
READINGS
CHAPTER 1
Buffa, E. S., and R. K. Sarin, Modern Production Operations Management, 8th ed.,
Chap. 2. New York: Wiley, 1987.
Hill, T. E. Manufacturing Strategy, 3rd ed. New York: McGraw-Hill, 2000.
CHAPTER 2
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Ling, R. C., and W. E. Goddard, Orchestrating Success. New York: John Wiley & Sons,
1988.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chap. 7. Englewood Cliffs, NJ: Prentice Hall, 1985.
Vollmann, T. E., W. L. Berry, D. C. Whybark, and F. R. Jacobs, Manufacturing
Planning and Control Systems for Supply Chain Management, 5th ed. New York:
McGraw-Hill, 2005.
Wallace, T. F., and R. A. Stahl, Sales and Operations Planning: The Executive’s Guide.
Cincinnati, OH: T. F. Wallace & Company, 2006.
CHAPTER 3
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Mather, H., Competitive Manufacturing. Englewood Cliffs, NJ: Prentice Hall, 1988.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chap. 7. Englewood Cliffs, NJ: Prentice Hall, 1985.
503
504
Readings
Schonberger, R. J., and E. M. Knod, Operations Management: Serving the Customer,
3rd ed., Chap. 6. Plano, TX: Business Publications, 1988.
Vollmann, T. E., W. L. Berry, D. C. Whybark, and F. R. Jacobs, Manufacturing
Planning and Control Systems for Supply Chain Management, 5th ed. New York:
Irwin, 1992.
CHAPTER 4
Buffa, E. S., and R. K. Sarin, Modern Production Operations Management, 8th ed.,
Chap. 6. New York: Wiley, 1987.
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Garwood, D., Bills of Material: Structured for Excellence. Marietta, GA: Dogwood
Publishing, 1988.
Mather, H., Bills of Materials, Recipes and Formulations. Atlanta, GA: Wright
Publishing, 1982.
Orlicky, J., Material Requirements Planning. New York: McGraw-Hill, 1975.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chap. 6. Englewood Cliffs, NJ: Prentice Hall, 1985.
Vollmann, T. E., W. L. Berry, D. C. Whybark, and F. R. Jacobs, Manufacturing
Planning and Control Systems for Supply Chain Management, 5th ed. New York:
Irwin, 1992.
CHAPTER 5
Blackstone, J. H., Jr., Capacity Management. Cincinnati, OH: South-Western, 1989.
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chap. 9. Englewood Cliffs, NJ: Prentice Hall, 1985.
Vollmann, T. E., W. L. Berry, D. C. Whybark, and F. R. Jacobs, Manufacturing
Planning and Control Systems for Supply Chain Management, 5th ed. New York:
Irwin, 1992.
CHAPTER 6
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Goldratt, E. M., and J. Cox, The Goal, rev. ed. Croton-on-Hudson, NY: North River
Press, 1986.
Goldratt, E. M., and R. E. Fox, The Race. Croton-on-Hudson, NY: North River
Press, 1986.
Readings
505
Melnyk, S. A., and N. L. Carter, Production Activity Control, A Practical Guide.
Homewood, IL: Dow Jones-Irwin, 1987.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chaps. 10–12. Englewood Cliffs, NJ: Prentice Hall, 1985.
Vollmann, T. E., W. L. Berry, D. C. Whybark, and F. R. Jacobs, Manufacturing Planning
and Control Systems for Supply Chain Management, 5th ed. New York: Irwin, 1992.
CHAPTER 7
Ammer, D. S., Materials Management and Purchasing, 4th ed. Homewood, IL: Irwin,
1980.
Colton, R. R., and W. F. Rohrs, Industrial Purchasing and Effective Materials
Management. Reston, VA: Reston, 1985.
Dobbler, D. W., L. Lee, and D. Burt, Purchasing and Materials Management. New
York: McGraw-Hill, 1984.
Zenz, G. J., Purchasing and the Management of Materials, 6th ed. New York: Wiley, 1987.
CHAPTER 8
Buffa, E. S., and R. K. Sarin, Modern Production Operations Management, 8th ed.,
Chap. 4. New York: Wiley, 1987.
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chaps. 4 and 5. Englewood Cliffs, NJ: Prentice Hall, 1985.
Schonberger, R. J., and E. M. Knod, Operations Management: Serving the Customer,
3rd ed., Chap. 4. Plano, TX: Business Publications, 1988.
Vollmann, T. E., W. L. Berry, D. C. Whybark, and F. R. Jacobs, Manufacturing Planning
and Control Systems for Supply Chain Management, 5th ed. New York: Irwin, 1992.
CHAPTER 9
Buffa, E. S., and R. K. Sarin, Modern Production Operations Management, 8th ed.,
Chap. 5. New York: Wiley, 1987.
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chap. 2. Englewood Cliffs, NJ: Prentice Hall, 1985.
Schonberger, R. J., and E. M. Knod, Operations Management: Serving the Customer,
3rd ed., Chap. 7. Plano, TX: Business Publications, 1988.
Vollmann, T. E., W. L. Berry, D. C. Whybark, and F. R. Jacobs, Manufacturing Planning
and Control Systems for Supply Chain Management, 5th ed. New York: Irwin, 1992.
506
Readings
CHAPTERS 10 AND 11
Buffa, E. S., and R. K. Sarin, Modern Production Operations Management, 8th ed.,
Chap. 5. New York: Wiley, 1987.
Coyle, John J., Edward J. Bardi, and C. John Langley, Jr., The Management of
Business Logistics, 7th ed. Mason, OH:.
Fogarty, D. W., Blackstone, J. H., and T. R. Hoffmann, Production and Inventory
Management, South-Western Publisher, Cincinnati, OH: 1990.
Martin, A. J., Distribution Resource Planning. Essex Junction, VT: Oliver Wight
Publications, 1983.
Plossl, G. W., Production and Inventory Control, Principles and Techniques, 2nd ed.,
Chap. 3. Englewood Cliffs, NJ: Prentice Hall, 1985.
Summers, Donna C. S. Quality, 4th ed. Upper Saddle River, NJ: Pearson, 2006.
CHAPTERS 12 AND 13
Ackerman, K. B., Warehousing, A Guide for Both Users and Operators. Washington,
DC: Traffic Service Corp., 1977.
Apple, J. M., Material Handling Systems Design. New York: Ronald Press, 1972.
Ballou, Ronald H., Business Logistics Management, 3rd ed. Englewood Cliffs, NJ:
Prentice Hall, 1992.
Blanding, W., Blanding’s Practical Physical Distribution. Washington, DC: Traffic
Service Corp., 1978.
Bowersox, D. J., P. J. Calabro, and G. D. Wagenheim, Introduction to Transportation.
New York: Macmillan, 1981.
Bowersox, D. J., D. J. Closs, and O. K. Helferich, Logistical Management, 3rd ed. New
York: Macmillan, 1986.
Coyle, J. J., E. J. Bardi, and C. J. Langley, The Management of Business Logistics,
4th ed. St. Paul, MN: West Publishing, 1988.
Johnson, J. L., and D. F. Wood, Contemporary Physical Distribution and Logistics,
3rd ed. New York: Macmillan, 1986.
Lieb, R. C., Transportation, The Domestic System. Reston, VA: Reston, 1978.
CHAPTER 14
Arnold, J. R., and L. M. Clive, Introduction to Operations Management. Qualicum
Beach, BC: J. R. Arnold & Associates Ltd., 1996.
Chase, R. B., and N. J. Aquilano, Production and Operations Management. Chicago:
Richard D. Irwin, 1995.
Schonberger, R. J., and E. M. Knod, Operations Management. Chicago: Richard D.
Irwin, 1995.
Readings
507
Starr, M. K., Operations Management. Danvers, MA: Boyd & Fraser Publishing, 1996.
Turner, W. C., et al. Introduction to Industrial and Systems Engineering. Englewood
Cliffs, NJ: Prentice Hall, 1993.
CHAPTER 15
Goddard, W. E., Just-in-Time: Surviving by Breaking Tradition. Essex Junction, VT:
Oliver Wight Publications, 1986.
Hall, R. W., Zero Inventories. Homewood, IL: Dow Jones-Irwin, 1983.
Hall, R. W., Attaining Manufacturing Excellence. Homewood, IL: Dow JonesIrwin, 1987.
Schonberger, R. J., Japanese Manufacturing Techniques: Nine Hidden Lessons in
Simplicity. New York: Free Press, 1982.
Schonberger, R. J., World Class Manufacturing: The Lessons of Simplicity Applied.
New York: Free Press, 1986.
Suzaki, K., The New Manufacturing Challenge: Techniques for Continuous Improvement.
New York: Free Press, 1987.
Wemmerl^v, U., Production Planning and Control Procedures for Cellular
Manufacturing. Falls Church, VA: American Production and Inventory Control
Society, 1988.
Womack, J. P., and D. T. Jones, Lean Thinking. New York: Simon & Schuster, 1996.
CHAPTER 16
Arnold, J. R., and L. M. Clive, Introduction to Operations Management. Qualicum
Beach, B C: J. R. Arnold & Associates Ltd., 1996.
Besterfield, D. H., C. Besterfield-Michna, G. H. Besterfield, and M. BesterfieldSacre, Total Quality Management. Englewood Cliffs, NJ: Prentice Hall, 1995.
Chase, R. B., and N. J. Aquilano, Production and Operations Management. Chicago:
Richard D. Irwin, 1995.
Juran, J. M., and A.B. Godfrey, Juran’s Quality Handbook, 5th ed. New York:
McGraw-Hill Professional, 1998.
Schonberger, R. J., Japanese Manufacturing Techniques. New York: Free Press, 1982.
Schonberger, R. J., and E. M. Knod, Operations Management. Chicago: Richard D.
Irwin, 1995.
Starr, Martin K., Operations Management. Danvers, MA: Boyd & Fraser, 1996.
Summers, Donna C. S., Quality, 4th ed. Upper Saddle River, NJ: Pearson, 2006.
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INDEX
A
ABC inventory, 270–274
Acceptance sampling, 484
Accessibility, 338
Accounting equation, 265
Action bucket, 97
Adding value, 430
Aggregate inventory management, 255
Anticipation inventories, 258
Anticipation inventory, 295
Appraisal costs, 472
Approving payment, 195
Assemble-to-order, 5, 39, 57
Asset, 265
Assignable variation, 474
Available facilities, 14
Available time, 132
Available to promise (ATP), 61
Average, 310
Average cost, 270
Average demand, 225
B
Backflushing, 446
Backlog, 39
Back scheduling, 138–139
Backward scheduling, 161, 162
Balance sheet, 265, 266
Balancing the line, 439
Basic MRP record, 96–97
Bell curve, 309
Benchmarking, 489
Bias, 233
Bill of material, 14
indented bill, 86, 87
multilevel bills, 82–83
multiple bill, 83
parent-component relationship, 82
pegging report, 88
planning bills, 87
product tree, 82
single-level bill, 83–85
summarized parts list, 86
where-used report, 88
Bottlenecks, 167–170
Bottom-up replanning, 106
Boundary spanners, 6
Break-bulk, 377
Break-even point, 205
Buyer specifications, 199
C
Calculated or rated capacity, 132
Capacity, 21
Capacity-associated costs, 264
Capacity available, 130–131
Capacity control, 126
Capacity management, 26, 126, 446
available time, 132
back scheduling, 138–139
calculated or rated capacity, 132
capacity available, 130–131
capacity control, 126
capacity management, 126
capacity planning, 126, 127–128
capacity required (load), 126, 135–138
capacity requirements planning (CRP),
127–128, 128–130
definition of capacity, 125–126
demonstrated (measured) capacity,
132, 134
determining capacity available, 132
efficiency, 133
inputs, 129
lead time, 130
levels of capacity, 132
load, 126, 136
measuring capacity, 131–132
move time, 130
open order file, 129
planned order releases, 129
queue time, 130
rated capacity, 133–134
resource planning, 127
rough-cut capacity planning, 127
routing file, 129
scheduling orders, 138–141
shop calendar, 130
standard time, 131–132
units of output, 131
utilization, 132–133
wait time, 130
work center file, 129–130
work center load report, 137
Capacity planning, 126, 127–128
Capacity required (load), 126, 135–138
Capacity requirements planning (CRP), 97,
127–128, 128–130
Capital, 266
Card alternatives, 453
Carriage, costs of, 369
Carrying costs, 262
Cash flow analysis, 267, 268
Cause-and-effect diagram, 415
Cause-and-effects (fishbone) diagram, 483
Centralized system, 324
Central storage, 341
Chance variation, 473
Chase (demand matching) strategy, 32–33
Chase strategy, 38–39
Checksheets, 483
Classes of activity, 416–417
Common carrier, 371
Competition, 2
509
510
Index
Competitive bidding, 206
Component standardization, 431
Concurrent engineering, 400
Constraints, theory of, 170–172
Consumer’s risk, 485
Continuous manufacturing, 156, 404
Continuous process improvement (CPI),
441, 470
analysis, 419
cause-and-effect diagram, 415
classes of activity, 416–417
developing solutions, 420
economic considerations, 412–413
human and environmental factors,
421–422
human factor, 413
learning curve, 422
maintenance, 422
motion economy, principles of, 420
objectives, 410–411
operations process charts, 418
Pareto diagrams, 413
people improvement, 411
process flow diagrams, 418, 419
productivity, improving, 411
record, 416
root cause, finding the, 419–420
steps of, 412–413
teams, 411
Contract buying, 208
Contract carriers, 372
Control, 155, 174–180
Control charts, 480–481
Control files, 158
Control limits, 481–482
Conveyors, 385
Cost equalization point (CEP), 409–410
Cost of goods sold, 266
Costs, 261–265
Costs of failure, 472
Cost trade-off, 366
Count frequency, 348
Cpk index, 479
Cranes, 386
Critical ratio (CR), 178
Cube utilization and accessibility, 337–339
Cumulative variance, 174
Customer focus, 469
Cycle counting, 348
Cycle stock, 258
Cycle time, 160
D
Data collection and preparation, 222–223
Data requirements, 157–159
Days of supply, 29
Decentralized system, 323
Decline phase, 395
Delivery lead time, 4
Demand forecasting, 218
average demand, 225
bias, 233
characteristics of demand, 218–220
data collection and preparation, 222–223
demand lead time, 240
dependent versus independent demand,
220–221
deseasonalized demand, 229, 231–233
economic indicators, 223–224
exponential smoothing, 227–229
extrinsic forecasting techniques, 223
forecast error, 233–236
intrinsic forecasting techniques, 224–227
mean absolute deviation (MAD),
236–237, 237
moving average, 225, 227
normal distribution, 237
P/D ratio, 239–240
principles of, 221
production lead time, 239
qualitative techniques, 223
random variation, 220, 235–236
seasonal forecasts, 230–231
seasonal index, 229
seasonality, 219, 220, 229
smoothing constant, 227
stable versus dynamic, 220
tracking signal, 238
trend, 219
Demand lead time, 240
Demand management, 217–218
Demand time fence, 63, 66
Demonstrated (measured) capacity,
132, 134
Density, 376
Dependent versus independent demand,
220–221
Deseasonalized demand, 229, 231–233
Determining capacity available, 132
Differing forecast and lead-time intervals,
316–317
Dispatching, 177–180
Dispersion, 311
Distribution channel, 361–363
Distribution inventories, 257, 322–326
Distribution requirements planning,
324–326
Distribution warehouse, 377
Drum-Buffer-Rope, 170, 171, 457
E
Economic-order quantity (EOQ), 282–288
Effective lot sizing, 446–447
Efficiency, 133
Electronic data interchange (EDI), 209
Employee empowerment, 421
Empowerment, 470
Engineer-to-order, 4–5, 59
Enterprise resource planning (ERP), 29–30
Error management, 66
Exception messages, 104
Exploding and offsetting, 90
Exponential smoothing, 227–229
External failure costs, 472
Extranet, 209
Extrinsic forecasting techniques, 223
F
Fair price, 204
Final assembly schedule (FAS), 57, 58
Financial statements and inventory,
265–270
Finished goods, 256
Finite loading, 162
Firm planned orders, 104
First in first out (FIFO), 270
Fishbone diagrams, 483
Fixed costs, 205, 369, 407
Fixed-location system, 340–341
Fixed-order quantity, 282
Floating-location system, 341
Flow manufacturing, 156, 434
Flow of material, 256–257
Flow processing, 404–405
Fluctuation inventory, 258
Focused factory, 398
Forecast error, 233–236
For hire carrier, 371–372
Forward scheduling, 161, 162
Frozen zone, 66
Functional specifications, 196, 198–200
G
General-purpose machinery, 404
General warehouse, 377
Global distribution, 366–367
Gross and net requirements, 92–93
Growth phase, 395
H
Hedge inventory, 259
Hoists, 386
Human factor, 413
Hybrid strategy, 35
Hybrid systems, 457–458
I
Income, 266
Income statement, 266
Indented bill, 86, 87
Industrial trucks, 385
511
Index
Infinite loading, 162
Input/output control, 174–175
Input/output report, 174
Inputs, 129
100% inspection, 484
Interfaces, 367–368
Intermittent manufacturing, 156,
405–406
Internal failure costs, 472
Internet, role of, 209
Intranet, 209
Intrinsic forecasting techniques, 224–227
Introduction phase, 395
Inventory
ABC inventory, 270–274
anticipation inventories, 258
average cost, 270
capacity-associated costs, 264
carrying costs, 262
costs, 261–265
cycle stock, 258
days of supply, 29
distribution inventories, 257
financial statements and inventory,
265–270
first in first out (FIFO), 270
flow of material, 256–257
fluctuation inventory, 258
functions of, 257–259
hedge inventory, 259
inventory turns, 268
item cost, 261
landed price, 262
last in first out (LIFO), 270
lot-size inventories, 258
maintenance, repair, and operational
supplies (MROs), 257, 259
movement inventories, 258
objectives of, 259–261
ordering costs, 263
Pareto’s law, 271
physical control and security, 342–343
pipeline inventories, 258
record accuracy, 343–350
safety stock, 258
standard cost, 270
stockout costs, 264
supply and demand patterns, 257
transportation inventories, 258
Inventory management, 13, 446
Inventory record file, 81
Inventory records, 79–80
Inventory turns, 268
ISO 9000:2000, 486–489
Item cost, 261
Item inventory management, 255
Item master file, 157
J
JIT and TOC, 458
Job design, 421
Job enlargement, 421
Job enrichment, 421
Job rotation, 421
Just-in-time environment, 434–443
Just-in-time manufacturing, 457
adding value, 430
backflushing, 446
balancing the line, 439
capacity management, 446
card alternatives, 453
component standardization, 431
continuous process improvement,
441
effective lot sizing, 446–447
flow manufacturing, 434
inventory management, 446
just-in-time environment, 434–443
Kanban system, 450–453, 454
lean production, 454–456
linearity, 440
machine flexibility, 436
manufacturing planning and control,
443–454
master production scheduling, 444
materials requirements planning,
445–446
mixed-model scheduling, 440
objectives, 430
operator flexibility, 437
partnering, 441
poke-poke (fail safe), 433–434
post-deduct, 446
process flexibility, 436
production planning, 444
pull system, 439, 447–450
quality at the source, 438
quick changeover, 436, 437
supplier partnerships, 441
supplier selection and certification,
442
total employee involvement, 442
total productive maintenance, 438
total quality management (TQM),
437–438
uniform plant loading, 439
uninterrupted flow, 439–440
valid schedule, 439–440
waste, 431–434
work cells, 435–436
K
Kaizen, 455
Kanban system, 318, 450–453, 454, 457
Kanban system and MRP, 457–458
L
Laid-down cost (LDC), 380
Landed price, 262
Last in first out (LIFO), 270
Lead time, 90, 130, 305
Lean production, 454–456
Learning curve, 422
Level production plan, 36–37,
39–40
Liabilities, 265
Linearity, 440
Line-haul cost per hundredweight, 373
Linkages to other planning and control
functions, 79–80
Liquid zone, 66
Load, 126, 136
Load leveling, 166–167
Location audit system, 350
Lost capacity cost, 263
Lot-for-lot, 282
Lot-size decision rules, 282
Lot-size inventories, 258
Low-cost processing, 399
Lower specification limit (LSL), 476
Low-level coding and netting, 97–100
Lumpy demand, 295
M
Machine flexibility, 436
Maintenance, repair, and operational
supplies (MROs), 257, 259
Make-to-order production plan, 5,
39, 57
Make-to-stock production plan, 5, 35–36
Make-to-stock products, 57
Manufacturing lead time (MLT), 160–161
Manufacturing planning and control, 13–14,
443–454
Manufacturing resource planning (MRP
II), 28–29, 456–457
Manufacturing strategy, 4–5
Manufacturing systems, 155
Market boundary, 381
Mass customization, 401
Master production schedule (MPS), 21,
24–25, 49, 80
available to promise (ATP), 61
delivery promises, and, 61–63
demand time fence, 63
development of, 53–59
differences, resolution of, 56–59
error management, 66
planning horizon, 59
preliminary master production schedule,
53–54
production plan, relationship to,
50–51
512
Index
Master production schedule (cont.)
projected available balance (PAB), 63–64
rough-cut capacity planning, 55–56
scheduled receipt, 61
time fences, 65–66
Master scheduling, 25
Material requirements planning, impact of,
207–209
Materials handling, 384–386
Materials management
definition, 10–11
Materials requirements plan (MRP), 21, 25
action bucket, 97
basic MRP record, 96–97
bills of material (See Bills of material)
bottom-up replanning, 106
capacity requirements planning, 97
exception messages, 104
exploding and offsetting, 90
firm planned orders, 104
gross and net requirements, 92–93
inventory record file, 81
inventory records, 79–80
lead time, 90
linkages to other planning and control
functions, 79–80
low-level coding and netting, 97–100
management of, 105–107
multiple bills of material, 100–101
nature of demand, 77–78
net requirements, 96
objectives of, 78–79
offsetting, 90
open orders, 95
planned order receipt, 91
planned order release, 91
planned orders, 90, 103
planning factors, 80–81
planning horizon, 97
process of, 89–102
released orders, 104
releasing orders, 94–95
scheduled receipts, 95
system nervousness, reducing, 106
time buckets, 96
transaction messages, 104
use of, 102–107
Maturity or saturation phase, 395
Maximum-level inventory, 320–321
Mean, 310
Mean absolute deviation (MAD), 236–237,
237
Metrics, 15–17
Minimum order, 295
Min-max system, 282
Mixed-model scheduling, 440
Modularization, 397
Monetary unit lot size, 288–289
Motion economy, principles of, 420
Movement inventories, 258
Move time, 130, 160
Moving average, 225, 227
Multilevel bills, 82–83
Multiple bill, 83
Multiple bills of material, 100–101
Multiple sourcing, 201
Multi-warehouse systems, 386–389
N
Nature of demand, 77–78
Need for new products, 394–395
Nesting, 401
Net requirements, 96
Noninstantaneous receipt model, 289
Normal curve, 309
Normal distribution, 237, 308, 310
O
Offsetting, 90
Open order file, 129
Open orders, 95
Operation overlapping, 164–165
Operation sequencing, 177
Operations management, 2–4
Operation splitting, 165–166
Operations process charts, 418
Operator flexibility, 437
Ordering costs, 263
Order picking and assembly, 341–342
Order point system, 305–307
Order preparation, 159
Order processing, 217
Order qualifiers, 3
Order quantities
economic-order quantity (EOQ),
282–288
fixed-order quantity, 282
lot-for-lot, 282
lot-size decision rules, 282
min-max system, 282
monetary unit lot size, 288–289
noninstantaneous receipt model, 289
order n periods supply, 282
period-order quantity (POQ),
293–295
quantity discounts, 290
relevant costs, 284
stock-keeping unit (SKU), 281
time between orders, 293
trial-and-error method, 285–287
unknown costs, products with,
291–292
Order winners, 3
Owners’ equity, 265
P
Packaging, 376, 383–384
Pallet, 383
Pallet positions, 338
Parent-component relationship, 82
Pareto analysis, 413
Pareto charts, 483
Pareto diagrams, 413
Pareto’s law, 271
Partnering, 441
P/D ratio, 239–240
Pegging report, 88
People improvement, 411
Performance measure, 16
Performance standards, 16
Periodic (annual) inventory, 347, 348
Periodic review system, 320–322
Period-order quantity (POQ), 293–295
Perishability, 376
Permanent or static information, 319
Perpetual inventory record, 318
Physical control and security, 342–343
Physical distribution
activities, 364–365
billing and collection costs, 375
common carrier, 371
contract carriers, 372
distribution channel, 361–363
global distribution, 366–367
for hire carrier, 371–372
interfaces, 367–368
line-haul costs, 373
materials handling, 384–386
multi-warehouse systems, 386–389
packaging, 383–384
physical supply, 360
pickup and delivery costs, 375
private carriers, 372
reverse logistics, 363–364
terminal-handling costs, 375
total-cost concept, 365
total transportation costs, 375–376
transaction channel, 361–363
transportation, 368–371
transportation cost elements, 372–376
warehousing, 376–383
Physical supply, 360
Physical supply/distribution, 14
Pickup and delivery costs, 375
Pipeline inventories, 258
Planned order receipt, 91
Planned order releases, 91, 129
Planned orders, 90, 103
Planner/buyer concept, 207–208
Planning bills, 87
Planning factors, 80–81
Planning files, 157
513
Index
Planning horizon, 59, 97
Planning time fence, 66
Point-of-use storage, 341
Poke-poke (fail safe), 433–434
Post-deduct, 446
Preliminary master production schedule,
53–54
Prevention costs, 72
Price, determing, 194, 204–207
Price negotiation, 206–207
Priority, 20
Private carriers, 372
Process capability, 476–480
Process capacity index (Cp), 478
Process control, 480–483
Process design, 401, 402–403
Process flexibility, 436
Process flowcharts, 483
Process flow diagrams, 418, 419
Process focus, 398
Processing equipment, 403–404
Process specifications, 14
Producer’s risk, 485
Product and market focus, 397
Product description, 14
Product development principles, 396–398
Product groups, establishing, 31–32
Production activity control
backward scheduling, 161, 162
bottlenecks, 167–170
constraints, theory of, 170–172
continuous manufacturing, 156
control, 155, 174–180
control files, 158
critical ratio (CR), 178
cumulative variance, 174
cycle time, 160
data requirements, 157–159
dispatching, 177–180
Drum-Buffer-Rope, 170, 171
finite loading, 162
flow manufacturing, 156
forward scheduling, 161, 162
implementation, 154, 172–173
infinite loading, 162
input/output control, 174–175
input/output report, 174
intermittent manufacturing, 156
item master file, 157
load leveling, 166–167
manufacturing lead time (MLT),
160–161
manufacturing systems, 155
move time, 160
operation overlapping, 164–165
operation sequencing, 177
operation splitting, 165–166
order preparation, 159
overview, 153
planning, 154
planning files, 157
production reporting, 180
product structure file (bill of material
file), 157
project manufacturing, 157
queue time, 160
repetitive manufacturing, 156
routing file, 158
run time, 160
scheduling, 159–166
setup time, 160
shop order detail file, 159
shop order master file, 158–159
throughput, 167–168
throughput time, 160
wait time, 160
work center master file, 158
Production control costs, 263
Production lead time, 239
Production leveling, 33–34
Production plan, relationship to, 50–51
Production planning, 13, 21, 24, 444
assemble-to-order, 39
backlog, 39
characteristics, 32
chase (demand matching) strategy, 32–33
chase strategy, 38–39
hybrid strategy, 35
level production plan, 36–37, 39–40
make-to-order production plan, 39
make-to-stock production plan, 35–36
product groups, establishing, 31–32
production leveling, 33–34
resource planning, 41
subcontracting, 34–35
Production reporting, 180
Productivity, improving, 411
Product layout, 405
Product mixing, 377–378
Products
concurrent engineering, 400
continuous manufacturing, 404
decline phase, 395
flow processing, 404–405
focused factory, 398
general-purpose machinery, 404
growth phase, 395
intermittent manufacturing, 405–406
introduction phase, 395
low-cost processing, 399
mass customization, 401
maturity or saturation phase, 395
modularization, 397
need for new products, 394–395
nesting, 401
process design, 401, 402–403
processes, 401
process focus, 398
processing equipment, 403–404
product and market focus, 397
product development principles,
396–398
product layout, 405
project (fixed position) processes,
406–407
repetitive manufacturing, 404
simplification, 396
simultaneous engineering, 399–400
specialization, 397
special-purpose machinery, 404
specification and design, 398–400
standardization, 396–397
Product structure file (bill of material file),
157
Product tree, 82
Profit leverage, 191–192
Projected available balance (PAB), 63–64
Project (fixed position) processes, 406–407
Project manufacturing, 157
Pull system, 439, 447–450
Purchase order, issuing a, 194
Purchase order cost, 263
Purchasing
approving payment, 195
buyer specifications, 199
competitive bidding, 206
contract buying, 208
functional specifications, 196, 198–200
material requirements planning, impact
of, 207–209
multiple sourcing, 201
objectives, 192–193
planner/buyer concept, 207–208
price, determing, 194, 204–207
price negotiation, 206–207
profit leverage, and, 191–192
purchase order, issuing a, 194
purchasing cycle, 193
quotations, requesting, 194
ranking method, 203
receiving and accepting goods, 195
receiving and analyzing purchase
requisition, 193–194
single sourcing, 201
sole sourcing, 200
sourcing, 200–201
specifications, establishing, 195–197
standard specifications, 199–200
suppliers, selecting, 194, 200–204
supply chain management, and, 209–21
value analysis, 197
514
Index
Purchasing and production activity control
(PAC), 21, 25–26
Purchasing cycle, 193
Q
Qualitative techniques, 223
Quality at the source, 438
Quality control charts, 483
Quality function deployment (QFD),
491–493
Quantity discounts, 290
Queue time, 130, 160
Quick changeover, 436, 437
Quotations, requesting, 194
R
Random variation, 220, 235–236
Ranking method, 203
Rated capacity, 133–134
Raw materials, 256
R chart, 481
Receiving and accepting goods, 195
Receiving and analyzing purchase
requisition, 193–194
Record, 416
Record accuracy, 343–350
Released orders, 104
Releasing orders, 94–95
Relevant costs, 284
Repetitive manufacturing, 156, 404
Reserve stock, 340
Resource planning, 41, 127
Retained earnings, 266
Revenue, 266
Reverse logistics, 363–364
Root cause, finding the, 419–420
Rough-cut capacity planning, 55–56, 127
Routing file, 129, 158
Run charts, 480–481
Run time, 160
S
Safety factor, 314
Safety lead time, 307
Safety stock, 258, 307–314
Sales and operations planning (SOP),
26–28
5S approach, 456
Scatterplots, 483
Scheduled receipts, 61, 95
Scheduling, 159–166
Scheduling orders, 138–141
Seasonal forecasts, 230–231
Seasonal index, 229
Seasonality, 219, 220, 229
Self-check, 433
Self-directed teams, 421
Service levels, determining, 315–316
Setup and teardown costs, 263
Setup time, 160
Shop calendar, 130
Shop floor control, 13
Shop order detail file, 159
Shop order master file, 158–159
Simplification, 396
Simultaneous engineering, 399–400
Single-level bill, 83–85
Single sourcing, 201
Six Sigma, 489–491
Slushy zone, 66
Smoothing constant, 227
Sole sourcing, 200
Source inspection, 433
Sourcing, 200–201
Specialization, 397
Special-purpose machinery, 404
Specification and design, 398–400
Specifications, establishing, 195–197
Spread, 476
Stable versus dynamic, 220
Standard cost, 270
Standard deviation (Sigma), 311
Standardization, 396–397
Standard specifications, 199–200
Standard time, 131–132
Statistical control, 474
Stock-keeping unit (SKU), 281
Stock location, 340–341
Stockout costs, 264
Strategic business plan, 21, 22–24
Subcontracting, 34–35
Successive check inspection, 433
Summarized parts list, 86
Supplier flexibility and reliability, 208
Supplier partnerships, 441, 471
Suppliers, selecting, 194, 200–204
Supplier selection and certification, 442
Supply and demand patterns, 257
Supply chain management, 5–10
conflicts, 8–10
contemporary views, 8
factors, 6
growth of, 7
historical perspective, 6–7
organizational implications, 211
Supply chain metrics, 15–17
System nervousness, reducing, 106
System service capability, 388
Terminals, 369
Theory of constraints, 457
Third-party registration system, 487
Throughput, 167–168
Throughput time, 160
Time between orders, 293
Time buckets, 96
Time fences, 65–66
Time needed to perform operations, 14
Tolerance, 345
Total cost, 366
Total-cost concept, 365
Total employee involvement, 442
Total line-haul cost, 373
Total productive maintenance, 438
Total quality management (TQM), 437–438
assignable variation, 474
benchmarking, 489
chance variation, 473
concepts, 468–472
continuous process improvement, 470
costs of failure, 472
customer focus, 469
defining quality, 465–468
employee involvement, 470
empowerment, 470
ISO 9000:2000, 486–489
management commitment, 469
performance measures, 471–472
process capability, 476–480
process control, 480–483
quality, controlling, 472–473
quality control charts, 483
quality function deployment (QFD),
491–493
sample inspection, 484–486
Six Sigma, 489–491
statistical control, 474
supplier partnerships, 471
teams, 470
variation, 473–476
Total transportation costs, 375–376
Tracking signal, 238
Transaction channel, 361–363
Transaction messages, 104
Transportation, 368–371
Transportation consolidation, 377
Transportation cost elements, 372–376
Transportation inventory, 258, 295
Trial-and-error method, 285–287
Two-bin system, 318
T
Takt team, 455
Target-level inventory, 320–321
Teams, 411, 470
Terminal-handling costs, 375
U
Uniform plant loading, 439
Uninterrupted flow, 439–440
Unitization, 383
Unit loads, 383
515
Index
Units of output, 131
Unknown costs, products with, 291–292
Upper specification limit (USL), 476
Utilization, 132–133
V
Valid schedule, 439–440
Value, 376
Value analysis, 197
Value stream mapping, 455
Variable costs, 205, 369, 407
Variable or dynamic information, 319
Variation, 473–476
Vendor-managed inventory, 209
W
Wait time, 130, 160
Warehousing, 376–383
Warehousing management
accessibility, 338
activities, warehouse, 336–337
central storage, 341
cube utilization and accessibility,
337–339
fixed-location system, 340–341
floating-location system, 341
order picking and assembly, 341–342
pallet positions, 338
point-of-use storage, 341
reserve stock, 340
stock location, 340–341
working stock, 340
working stock and reserve stock,
340, 342
Waste, 431–434
Ways, 369
Where-used report, 88
Work cells, 435–436
Work center file, 129–130
Work center load report, 137
Work center master file, 158
Working stock, 340
Working stock and reserve stock,
340, 342
Work-in-process (WIP), 12, 256
X
X bar, 481
Z
Zone method, 349